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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [Fee Required]
For the fiscal year ended: December 31, 1997, Commission File No. 000-20731
PHOTRAN CORPORATION
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(Exact Name of Registrant as specified in its Charter)
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MINNESOTA 41-1697628
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(State of Incorporation) (I.R.S. Employer Identification No.)
21875 Grenada Avenue, Lakeville, Minnesota 55044
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(Address of Principal Executive Offices) (Zip Code)
(612) 469-4880
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(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No Par Value
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(Title of Class)
Check whether the Issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
twelve months (or for such shorter period that the Registrant was required to
file such reports) and (2) has been subject to such filing requirements for the
past 90 days. Yes X No
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Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation SB and no disclosure will be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X]
State Issuer's revenues for its most recent fiscal year: $4,382,600.
The aggregate market value of voting stock held by nonaffiliates of the Issuer
on March 20, 1998 was $15,036,043.
The number of shares outstanding of the Issuer's only class of common stock on
March 20, 1998, was 5,356,247.
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PART I
ITEM 1: DESCRIPTION OF THE BUSINESS
BUSINESS DEVELOPMENT
Photran Corporation ("Photran" or the "Company") was incorporated in 1991
under the laws of the State of Minnesota. During the past three years, the
Company has not changed its form of organization or mode of conducting business,
except that the Company commenced commercial scale production of indium tin
oxide ("ITO") coated glass for the first time in July of 1995.
GENERAL
The Company develops, manufactures and markets high performance optical and
electrically conductive, thin film coated products. The Company employs a
process based on a technology known as planar magnetron sputtering. This process
is used to apply microscopically thin layers of metal, metal oxide, nitride,
boride, carbide and fluoride to a wide variety of substrate materials. These
thin film coatings provide essential optical, electrical or durability
properties to a substrate material such as glass, metal, or plastic. The Company
began commercial scale production on its first coating line in July 1995. The
Company's first product is its PCO brand of ITO coated glass. ITO coated glass
consists of a high quality sheet of thin glass which the Company coats with a
transparent, electrically conductive ITO coating. ITO coated glass is a
principal component of flat panel displays. These displays are used in watches,
calculators, lap top computers and consumer electronics devices.
TECHNOLOGY
The Company's core manufacturing technology is based on a vacuum coating
process known as planar magnetron sputtering. This process is used to apply
microscopic thicknesses of thin film coatings onto a variety of substrate
materials. The coating process occurs in a specially designed vacuum chamber.
The source material for the coating is normally a metal plate referred to as the
"target," which is mounted on a device called a "magnetron sputtering cathode."
The cathode and target assembly becomes the negative terminal in an electrical
circuit. A regulated power supply energizes the cathode and target, providing a
source of electrons. A small volume of argon gas is introduced into the vacuum
chamber near the cathode. Electrons emitted from the cathode collide with these
argon atoms causing the argon atoms to become positively charged or "ionized."
The negative charge on the target provides a strong electrical attraction for
the argon gas ions causing them to strike the target with very high velocity.
The kinetic energy of the argon gas ions, which is transferred to the target
surface, results in an atom of the target material being "sputtered" off the
surface. The sputtered atom travels at a very high speed toward the substrate
material, which is passing through the vacuum chamber. The sputtered atom
strikes the substrate surface with sufficient force to form a strongly bonded
coating.
ITO COATED GLASS PRODUCTS AND MARKETS
To date, the Company's principal product has been its PCO brand twisted
nematic (TN) grade ITO coated glass. The Company had orders for approximately
1,500,000 pieces of ITO coated glass as of December 31, 1997. The Company has
also produced enhanced reflection mirrors in limited quantities.
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PCO BRAND TN GRADE AND LCM BRAND STN GRADE ITO COATED GLASS. The first
product the Company introduced was its TN grade ITO coated glass that is the
primary material used to construct many types of flat panel displays. The most
common type of flat panel display is the TN grade liquid crystal display
("LCD"), which is used in watches, calculators, electronic games and most types
of inexpensive consumer electronics devices. These displays, which incorporate
TN grade ITO coated glass, are produced in very high volume by an estimated 200
display manufacturing companies located in Japan and other Asian countries.
To further its market position and to attempt to secure higher margins,
the Company is developing a new ITO coated glass product for the
high-resolution super twisted nematic ("STN") segment of this market. This
type of coated glass is used in laptop computer screens and other higher
quality graphical image display. The Company's existing production lines are
capable of producing STN grade ITO coated glass and the Company has sold its
LCM brand STN grade ITO coated glass in limited quantities. In 1998 the
Company plans to continue to focus on development of the STN grade market and
to expand its production capacity to allow for greater output of TN grade and
STN grade ITO coated glass.
TOUCH SCREEN PANELS. The Company also coats glass panels with ITO and
antimony tin oxide materials. These coated glass panels are the principal
material component in all resistive and capacitive type touch screens. Resistive
and capacitive type touch screens account for the majority of the touch screen
market.
A/R PRODUCTS AND MARKETS
Anti-reflection ("A/R") coatings consist of microscopically thin layers of
metal and metal oxide materials that utilize the principle of light wave
interference to reduce the reflectivity of the surface of a glass or plastic
substrate. The Company is currently developing the two A/R products described
below.
POLARCLEAR POLARIZING FILM. The Company's PolarClear product will
consist of a sheet of plastic polarizing film, which is available from
several sources in the U.S. and Asia, to which the Company will apply an A/R
coating. The Company does not currently have the production equipment
necessary to apply thin films to flexible substrates such as polarizing film.
The Company does not anticipate building or obtaining such equipment
during 1998. Every LCD display utilizes a plastic polarizing film on the
front of the display.
ARTGLAS PICTURE FRAMING GLASS. ArtGlas picture framing glass will
consist of a high quality sheet of clear glass that the Company will coat
with A/R and UV light blocking coatings. UV light is present at very damaging
levels in sunlight and most fluorescent light. It is the primary cause of
irreversible fading in paintings, prints and photographs. The Company's
current production equipment cannot coat glass in large enough sizes or in
sufficient quantities to be economically feasible. The Company does not
anticipate building or obtaining equipment capable of producing ArtGlas
during 1998.
The Company estimates that between 10 percent and 12 percent of the glass
currently used for picture framing is a chemically etched "non glare" type of
glass. This product reduces glare by creating a matte texture for the picture or
artwork. Although it reduces glare, etched glass also reduces the image clarity
and color fidelity. The Company is aware of two A/R coated picture framing glass
products produced by a chemical dip process but is not aware of any A/R picture
framing glass coating applied using sputtering technologies.
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The Company plans to sell ArtGlas for approximately the same price as
existing chemically dipped glass. The Company believes that the price and
performance qualities of ArtGlas will provide the Company with competitive
advantages in the picture framing glass market.
ENHANCED REFLECTION MIRROR PRODUCTS AND MARKETS
Enhanced reflection mirrors ("ERMs") are glass or plastic sheets coated
with highly reflective mirror coatings on the surface closest to the point of
use (front surface). The Company commenced shipments of ERM products on a
limited basis in 1996. To date, the Company's selling efforts with respect to
ERM products has been very limited. The Company intends to focus additional
development and selling efforts on certain Asian customers during 1998. ERM
products are not expected to contribute materially to the Company's revenues in
1998.
PMAX ENHANCED REFLECTION MIRRORS. The Company's PMAX enhanced reflection
mirrors consist of a polished glass sheet coated with an ultra-high reflection
mirror coating on the front surface. Front surface mirrors are used in all
photocopiers, laser and bar code scanners, projection televisions, overhead
projectors and many other types of specialty mirror applications.
SALES AND DISTRIBUTION
The Company's sales and distribution activities are currently handled on a
direct basis and through selling agents. The Company's sales efforts are
currently conducted largely by senior management. Sales and distribution of
products under development will vary, depending on the product and the markets
to be pursued.
ITO PRODUCTS
ITO products are sold to manufacturers of flat panel displays. These
displays are used in such products as watches, calculators and lap top
computers. The Company sells its ITO coated glass and touch screen products
directly and through independent sales agents in the U.S. and Asia. This method
of distribution has provided a low cost, effective method of serving these
markets.
The Company has informal sales arrangements with several U.S. and Asian
sales agents. These sales agents are paid a sales commission that is standard
for the industry.
A/R PRODUCTS
POLARCLEAR POLARIZING FILM. PolarClear A/R and UV light blocking polarizing
films will be distributed through the Company's existing ITO coated glass
selling agents. This product is used by the same customers who purchase the
Company's ITO coated glass products.
ARTGLAS PICTURE FRAMING GLASS. ArtGlas will be sold on a wholesale basis to
a limited number of established distributors of picture framing glass in the
U.S. and Europe.
ENHANCED REFLECTION MIRROR PRODUCTS
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PMAX ENHANCED REFLECTION MIRRORS. To reach the markets for ERMs, the
Company will utilize sales agents to call on manufacturers of photocopiers,
laser and bar code scanners, overhead projectors and projection televisions.
COMPETITION
The Company has not yet shipped significant quantities of products in any
of the markets in which it intends to compete. It has not, therefore,
established a significant market presence in any of these markets.
ITO PRODUCTS
TN GRADE AND STN GRADE ITO COATED GLASS. Approximately half of the world's
production capacity for TN grade ITO coated glass is located in Japan. Japanese
LCD manufacturers utilize most of the ITO coated glass production capacity in
Japan. The principal suppliers of ITO coated glass for the LCD industry outside
of Japan are Applied Films Corporation of Boulder, Colorado; Samsung Corning of
Seoul, South Korea and Merck Balzers of Liechtenstein. These ITO suppliers have
substantial financial, technical, manufacturing and marketing resources, are
well established and will provide formidable competition to the Company for the
foreseeable future. The Japanese ITO coating manufacturers are not active in
supplying markets outside of Japan. However, to the extent the Company attempts
to develop business in Japan they will provide direct competition.
Because of the strong competition in the TN grade ITO coated glass market,
the Company is planning to focus on the higher quality, higher margin STN grade
segment of the ITO coated glass market. The Company believes that only three
Japanese ITO producers, as well as Samsung Corning and Applied Films
Corporation, are able to supply significant quantities of STN grade ITO coated
glass. The Company estimates that until recently, approximately 90 percent of
the demand for STN grade ITO coated glass was in Japan. However several new STN
grade LCD production lines have commenced production in Taiwan, Singapore, Korea
and Hong Kong. The Company believes that the non-Japanese markets for STN grade
ITO coated glass will be easier to penetrate than the Japanese market. The
Company, therefore, intends to target the non-Japanese markets for STN grade LCD
manufacturing.
TOUCH SCREEN PANELS. The only existing supplier of ITO and antimony tin
oxide coated panels for the touch screen market of which the Company is aware is
the Display Products Division of Donnelly Corporation in Holland, Michigan.
Donnelly has fully integrated production facilities for glass bending and thin
film coating. The Company's touch screen product is manufactured using a
different coating technology which the Company believes is more efficient than
the process used by its competitors. The Company intends, therefore, to compete
in this market on the basis of price.
A/R PRODUCTS
POLARCLEAR POLARIZING FILTERS. The market for A/R coated polarizing plastic
sheets has developed rapidly in the last three years. Currently, Optical Coating
Laboratory, Inc. (OCLI) of Santa Rosa, California and Nitto Denko of Japan
account for the majority of the market for A/R coated polarizing material. There
are five other principal suppliers of polarizing material
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worldwide. Three are in Japan and two are in the U.S. Each of these companies
has substantial manufacturing, technical, marketing and financial resources.
The Company believes the processes it has under development will enable it to
compete on the basis of both cost and quality.
ARTGLASS PICTURE FRAMING GLASS. There are two companies of which the
Company is aware that currently supply anti-reflection picture framing glass.
Denton Vacuum, Inc. of Cherry Hill, New Jersey, and Schott Glas Werks of Mainz,
Germany, sell anti-reflection picture glass for the framing market that is
manufactured by a chemical dip process. The Company believes its ArtGlass
product will have more effective optical and A/R properties than products
offered by competitors and believes that these properties will provide a
competitive advantage in this market. The Company plans to sell ArtGlass for
approximately the same price as existing chemically dipped glass.
ERM PRODUCTS
PMAX ENHANCED REFLECTION MIRRORS. The market for enhanced reflection
mirrors is currently being served by OCLI, Viratec Thin Films, Inc. (Viratec) of
Faribault, Minnesota and Opton, Inc. of Norfolk, Virginia. These three companies
are believed to supply more than 90 percent of the worldwide demand for ERMs.
All three companies have large manufacturing facilities in the U.S., Europe and
Asia for cutting and edge grinding of these products to meet end user
specifications. The Company intends to compete in this market on the basis of
price and quality.
RAW MATERIALS
The principal raw materials used in the Company's manufacturing processes
are glass substrates, which are coated with thin films, and the targets, which
are the source material for the thin film coatings. The glass used for ITO
coated glass is a special grade of thin soda lime glass. This material is
available from five suppliers worldwide. The Company currently purchases its
glass substrate from Glaverbel, S.A. of Belgium and NSG of Japan, although it
does not have a long term supply agreement with either of these suppliers. Other
suppliers are located in the U.K. and Japan. The Company believes that it can
obtain comparable quality material from other suppliers should its current
source be disrupted. Raw materials for products to be introduced in 1998 and the
target materials are widely available from a variety of sources.
CUSTOMERS
Sales to the Company's largest customer accounted for 82 percent of 1996
revenues. In 1997 this customer accounted for 54 percent of total revenues. In
1997 the Company expanded its customer base and two other customers accounted
for 24 and 13 percent of revenues, respectively. The Company does not have any
long-term contractual commitments from its customers. The Company sold its PCO
brand of ITO coated glass to a limited number of customers in 1996 and 1997,
primarily due to production capacity limitations. The Company expects to
increase its productive capacity during 1998, and anticipates that it will be
able to expand its ITO product customer base when this increased capacity is
available.
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The Company plans to further expand its customer base in the near term
through new product offerings. Based on current sales to and discussions with
its largest customer, however, the Company expects that the customer may
continue to be a significant portion of total revenue in 1998, if the Company's
STN products meet this customer's requirements, which could occur in the latter
half of 1998.
Customers for the Company's ITO coated glass products are predominantly
located in Asia. The Company anticipates that the initial customers for its A/R
and ERM products will be located predominantly in the U.S.
INTELLECTUAL PROPERTY
The Company's policy is to attempt to protect its technology by, among
other things, filing patent applications for technology that it considers
important to the development of its business. The Company has eight issued U.S.
patents, three U.S. patent applications which have been filed and 16 U.S. patent
applications which have been prepared and are in the process of being finalized
for filing. The validity and breadth of claims covered in the Company's patents
and patent applications involve complex legal and factual questions and,
therefore, may be highly uncertain. No assurance can be given that the Company's
pending applications will result in patents being issued or if issued that such
patents or the Company's existing patents will provide a competitive advantage,
or that competitors of the Company will not design around any patents issued to
the Company. Other than the prior art review done in connection with the
Company's patent applications, the Company has not undertaken any independent
investigation regarding potential infringement of its current or proposed
products on the property rights of others.
GOVERNMENT REGULATION; ENVIRONMENTAL LAWS
The Company's business is not subject to any material governmental
regulations, nor are any governmental approvals required for the operations of
the Company as currently conducted or anticipated to be conducted in the
foreseeable future. Costs and effects of environmental compliance are also not
material to the Company's business.
RESEARCH AND DEVELOPMENT
The Company spent $455,847 and $920,088 on research and development
activities in 1996 and 1997, respectively. None of these expenditures are
borne directly by customers. The increase in 1997 is due primarily to
engineering and process development costs associated with the installation of
the P-2 line. Such costs are expected to continue at approximately current
levels in 1998 as the Company adds productive capacity and develops its
manufacturing processes for new equipment and new products.
EMPLOYEES
As of December 31, 1997, the Company had 120 full-time employees. Of these
employees, 15 were in research and development and engineering, 69 were in
manufacturing and production, 20 were in machining, machine assembly and
facilities maintenance, one was in customer service, and 15 were in management
or administrative positions. None of the Company's employees are covered by a
collective bargaining agreement, and management considers its relations with its
employees to be good.
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ITEM 2 - DESCRIPTION OF PROPERTY
FACILITIES
The Company leases its main office and manufacturing facility located at
21875 Grenada Avenue, Lakeville, Minnesota 55044. This 23,000 square foot
facility consists of 16,000 square feet of manufacturing space (including
approximately 10,000 square feet of high quality environmentally controlled
clean room area). The remaining 7,000 square feet is used for administrative,
engineering, R & D and sales offices. The Company also leases a nearby 47,000
square foot building located at 21725 Hanover Avenue, Lakeville, Minnesota
55044. The Company uses this facility for its machine shop, shipping and
receiving, and another manufacturing line which is currently under
construction (the P-3 line). The Company believes these facilities are in
good condition and are adequate for the foreseeable future. The Company
carries insurance covering the full replacement value of these properties.
For discussion concerning the lease obligations, see Note 6 to Financial
Statements.
EQUIPMENT
At December 31, 1997 the Company operated a single in-line coating machine
which it has designated "P-1." The P-1 line is housed in a high quality
environmentally controlled clean room. It is being used primarily to produce ITO
coated glass. During 1997 the Company negotiated the cancellation of an
agreement to sell a coating line to a third party. The Company will now keep
this line, designated as "P-2," and is currently conducting trial production
runs on this line. The Company had also been constructing a coating line for
sale to a Chinese joint venture. During 1996, the joint venture partner
dissolved the joint venture and cancelled the equipment purchase contract. The
Company will now keep this coating line, designated as "P-3," and is currently
modifying it to suit the Company's manufacturing needs. The P-3 line is owned
by a lease financing company subject to the Company's obligation to purchase the
equipment at the end of the lease term. As of December 31, 1997 the Company was
in default on this lease and is currently attempting to refinance the lease
obligation. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations- Liquidity and Capital Resources." The Company
anticipates that the P-3 line will be operational beginning in the third quarter
of 1998.
The Company owns the majority of its manufacturing equipment (other than
the P-3) as well as equipment used in its research and development activities.
Some of the Company's machine shop and office equipment is subject to operating
and capital leases none of which are material to the Company's business. All of
the Company's personal property, whether owned or leased, is in good condition
and adequate for the foreseeable future.
ITEM 3 - LEGAL PROCEEDINGS
During the quarter ended December 31, 1996, the Company was informed by its
former Chinese joint venture partner, The Shenzhen WABO Group Co., Ltd.(WABO),
of their intention to dissolve the joint venture and cancel the related
equipment purchase contract. In April 1997, the Company received notice that
arbitration proceedings had been commenced against it by WABO, claiming
approximately $4,400,000 plus legal fees and costs. In January 1998, the
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Company and WABO negotiated a settlement that was approved by the Chinese
arbitration board in February 1998. Under the terms of this settlement, the
Company will pay WABO $1,500,000 in cash and issue 200,000 shares of common
stock to settle all claims in connection with the joint venture contract, the
equipment contract and related agreements. The cost of this settlement is
approximately $2,425,000 based on the market value of the Company's common
stock as of January 13, 1998. Of the $2,425,000 total, $1,735,435 is included
in customer advances as of December 31, 1996 and 1997. The balance of $689,565
was recorded as an arbitration settlement expense during the year ended
December 31, 1997.
In connection with the coating equipment that the Company was building for
sale to the joint venture, the Company entered into a contract with a third
party to design and build power supplies to be sold under the equipment
contract, as well as for the Company's own use. Due to the third party's failure
to perform its obligations, the Company rescinded the contract and demanded that
the third party refund all monies paid by the Company. The third party has
asserted that the Company is liable to it for various costs incurred in
connection with the production of the power supplies and has demanded payment of
$240,000 in addition to amounts the Company has already paid under the contract.
In June 1997, the third party formally brought an action against
the Company in Dakota County District Court. In the fourth quarter of 1997,
this third party increased its demand for damages to $1,300,000. Management, in
consultation with the Company's legal counsel, is of the opinion that the
Company has valid defenses against the claims asserted by the third party. The
Company has filed a counterclaim seeking the return of approximately $750,000 it
expended on the project. However, it is possible that the Company will be liable
for amounts in addition to those already paid under the contract. Such amounts
could be material but the Company is unable to estimate what amounts, if any,
will ultimately be paid.
In April 1997, the Securities and Exchange Commission (SEC) informed the
Company that it was conducting an investigation with respect to certain
financial and accounting irregularities announced by the Company in March 1997
relating to fiscal 1996. The Company has submitted documents to the SEC pursuant
to requests from the SEC as part of the investigation. The SEC has also
interviewed current and former employees of the Company. In the fourth quarter
of 1997, the Company was informed by the SEC that is has expanded its
investigation to include certain accounting and financial reporting
irregularities prior to 1996 which the Company announced in October 1997. The
investigation is in the preliminary stages and it is not possible to determine
what impact, if any, the investigation will have on the Company's financial
condition or results of operations.
In May of 1997 the Company was served with two separate lawsuits against the
Company, certain officers and directors of the Company, and the Company's former
president. These lawsuits were filed by certain purchasers of the Company's
common stock alleging that the Company's actions with respect to the financial
and accounting irregularities announced by the Company in March of 1997
artificially inflated its stock price between May 29, 1996 and March 24, 1997.
The plaintiffs subsequently amended their complaint to make similar allegations
with respect to the disclosures made by the Company in October of 1997. The
plaintiffs in these actions are seeking class certification. Both suits were
filed in the United States District Court for the District of Minnesota. In July
of 1997 the court consolidated these lawsuits into a single action captioned IN
RE PHOTRAN CORPORATION SECURITIES LITIGATION. The action seeks unspecified money
damages, attorney fees and unspecified further relief. The Company
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has moved the Court for an order dismissing the action; however, it is not
possible at this time to determine what impact, if any, this lawsuit will have
on the Company's financial position or results of operations.
In August 1997, the Company was served with a lawsuit by its former
president, David E. Stevenson, demanding the return of certain stock
certificates relating to 325,000 shares of the Company's common stock
registered in his name which are currently in the possession of the Company. In
October 1997, the Company filed a counterclaim alleging that Mr. Stevenson had
committed fraud and had damaged the Company and that his shares should be
awarded to the Company. The Company further alleged that Mr. Stevenson did not
provide adequate consideration for such shares and, therefore, such shares were
not properly issued. This suit is in the early stages of discovery and it is not
possible to determine what impact, if any, its outcome could have on the
Company's financial condition or results of operations.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted by the Company to a vote of security holders during
the quarter ended December 31, 1997.
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PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Company's common shares were listed on the NASDAQ National Market
under the symbol "PTRN." Effective January 13, 1998 the Company was delisted
from NASDAQ. The Company's stock currently trades on the electronic bulletin
boards. The high and low bid prices during 1997 and during the fiscal
quarters of 1996 following the Company's initial public offering, as reported
in the NASDAQ NMS monthly statistical report, were as follows:
<TABLE>
<CAPTION>
1996 1997
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High Low High Low
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<S> <C> <C> <C> <C>
First quarter $ 5 1/8 $ 1 5/8
Second quarter $ 14 1/4 $ 9 3/4 4 1/8 1 1/2
Third quarter 12 1/8 5 5/8 8 3 1/4
Fourth quarter 6 1/2 3 1/4 7 3/4 3 3/4
</TABLE>
There were approximately 124 shareholders of record as of December 31,
1997. The Company has not paid any dividends on its common shares and
anticipates retaining future earnings, if any, to finance operations of the
Company. Payment of dividends is restricted under the terms of the Company's
line of credit and the convertible debt issued in February 1998.
ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SELECTED QUARTERLY FINANCIAL DATA
<TABLE>
<CAPTION>
First Quarter Second Quarter Third Quarter
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1996 1997 (1) 1996 1997 1996 1997
---- -------- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Revenues . . . . . . . . . . . . . . . . $ 677,459 $ 567,951 $ 803,567 $ 867,908 $ 758,085 $ 1,135,462
Gross profit (loss). . . . . . . . . . . 251,752 (349,781) 64,958 (216,802) (94,495) (7,303)
Other non-recurring charges. . . . . . . 198,710
Loss from operations . . . . . . . . . . (69,549) (1,129,401) (272,136) (853,571) (441,556) (1,623,770)
Loss before extra-ordinary item. . . . . (235,380) (1,123,678) (351,729) (784,654) (363,907) (1,600,879)
Net loss . . . . . . . . . . . . . . . . (235,380) (1,123,678) (423,719) (784,654) (363,907) (1,600,879)
Basic and diluted loss per share:
Loss before extra-ordinary item (2). . . (0.08) (0.22) (0.10) (0.15) (0.07) (0.31)
Net loss (2) . . . . . . . . . . . . . . (0.08) (0.22) (0.12) (0.15) (0.07) (0.31)
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Total assets . . . . . . . . . . . . . . 12,642,013 22,196,899 23,167,660 21,383,840 22,663,653 21,662,887
Long-term debt less current portion. . . 290,318 4,094,953 152,726 3,803,433 104,040 4,395,999
<CAPTION>
Fourth Quarter Total Year
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1996 (1) 1997 1996 1997
-------- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues . . . . . . . . . . . . . . . . $ 655,349 $ 1,811,279 $ 2,904,460 $ 4,382,600
Gross profit (loss). . . . . . . . . . . (710,802) 284,526 (488,587) (289,360)
Other non-recurring charges. . . . . . . 2,216,894 2,216,894 198,710
Loss from operations . . . . . . . . . . (3,840,733) (940,838) (4,623,974) (4,547,580)
Loss before extra-ordinary item. . . . . (3,793,311) (1,814,545) (4,744,327) (5,323,756)
Net loss . . . . . . . . . . . . . . . . (3,793,311) (1,814,545) (4,816,317) (5,323,756)
Basic and diluted loss per share:
Loss before extra-ordinary item (2). . . (0.88) (0.35) (1.13) (1.03)
Net loss (2) . . . . . . . . . . . . . . (0.88) (0.35) (1.15) (1.03)
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Total assets . . . . . . . . . . . . . . 19,282,393 21,978,183 19,282,393 21,978,183
Long-term debt less current portion. . . 327,813 1,023,653 327,813 1,023,653
</TABLE>
(1) See Results of Operations - Other Nonrecurring Charges.
(2) See Results of Operations - Net Loss per Common Share
10
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FORWARD LOOKING STATEMENTS
THIS FORM 10-KSB CONTAINS FORWARD-LOOKING STATEMENTS AS DEFINED IN
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. THESE
FORWARD-LOOKING STATEMENTS INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES,
INCLUDING DEMAND FROM MAJOR CUSTOMERS, EFFECTS OF COMPETITION, CHANGES IN
PRODUCT OR CUSTOMER MIX OR REVENUES AND IN THE LEVEL OF OPERATING EXPENSES,
RAPIDLY CHANGING TECHNOLOGIES AND THE COMPANY'S ABILITY TO RESPOND THERETO,
THE IMPACT OF COMPETITIVE PRODUCTS AND PRICING, THE TIMELY COMPLETION OF
CONSTRUCTION AND INSTALLATION, AND THE ACTUAL PERFORMANCE, OF NEW
MANUFACTURING EQUIPMENT, THE TIMELY DEVELOPMENT AND ACCEPTANCE OF NEW
PRODUCTS, THE OUTCOME OF PENDING LITIGATION, THE ABILITY TO OBTAIN ADDITIONAL
CAPITAL, AND OTHER FACTORS DISCLOSED THROUGHOUT THIS FORM 10-KSB. THE ACTUAL
RESULTS THAT THE COMPANY ACHIEVES MAY DIFFER MATERIALLY FROM ANY
FORWARD-LOOKING STATEMENTS DUE TO SUCH RISKS AND UNCERTAINTIES. THE COMPANY
UNDERTAKES NO OBLIGATION TO REVISE ANY FORWARD-LOOKING STATEMENTS IN ORDER TO
REFLECT EVENTS OR CIRCUMSTANCES THAT MAY ARISE AFTER THE DATE OF THIS REPORT.
READERS ARE URGED TO CAREFULLY REVIEW AND CONSIDER THE VARIOUS DISCLOSURES
MADE BY THE COMPANY IN THIS REPORT, INCLUDING THE DISCUSSION SET FORTH IN THE
SECTION TITLED MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS -- OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING
RESULTS, AND IN THE COMPANY'S OTHER REGISTRATION STATEMENTS AND REPORTS FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION FROM TIME TO TIME THAT ATTEMPT TO
ADVISE INTERESTED PARTIES OF THE RISKS AND FACTORS THAT MAY AFFECT THE
COMPANY'S BUSINESS AND RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
REVENUES
For the year ended December 31, 1997 revenues increased 51 percent to
$4,382,600 from $2,904,460 in 1996. Revenues consisted primarily of gross sales
of TN grade ITO coated glass. The increase in revenue for the year ended
December 31, 1997 compared to 1996 is due primarily to increased unit sales in
1997. The Company's unit sales volume increased approximately 110 percent in
1997 over 1996 levels. This unit volume increase was partially offset by lower
per unit revenue. The Company's principal customer provided their own glass for
the majority of 1997 and the Company reduced the unit price charged to the
customer for this glass allowance. In addition, this customer changed to a
smaller substrate size with a lower unit price in the third quarter of 1996.
These changes had the combined result of reducing the amount of revenue recorded
per unit by approximately 55 percent on sales to this customer.
The market price for TN grade ITO coated glass declined during 1996 and
stabilized at these lower prices during 1997. Also, due to the Company's
desire to expand its customer base and reduce reliance upon a single
customer, the Company priced its product at or below the prevailing market
prices to attract new customers. The Company expects market prices to remain
stable during 1998, and expects to continue its current pricing practices.
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The Company experienced difficulties in 1997 in bringing its second
production line (the P-2 line) into service and therefore did not experience a
significant increase in capacity due to new production equipment. The Company is
currently resolving what it believes are the final technological and design
issues with the production line, and expects the P-2 line to be operating near
capacity beginning in the second quarter of 1998. The Company did increase
the quality and efficiency of its existing production line (the P-1 line),
reducing scrap and increasing output by nearly 95 percent over 1996 levels.
Based on recent discussions with its Asian selling agents and current customers,
management anticipates significant growth in revenue from the sale of ITO coated
glass in 1998 following the addition of productive capacity.
During 1996 the Company dedicated a significant portion of its available
production time on its P-1 line to the development of full scale production
processes for enhanced reflection mirrors and its LCM brand ITO coated glass. In
1997, these processes were modified and are expected to run with greater
efficiency on the P-2 line once it is operational. The P-2 line will also be
capable of efficiently producing STN grade ITO coated glass, which is a higher
quality, higher margin product that is also used by many of the Company's
current customers. The Company is providing samples to prospective customers and
is working with its independent sales representatives to develop customers for
its STN product.
The Company's largest customer accounted for 82 percent and 54 percent
of the Company's revenue during 1996 and 1997, respectively. Based on recent
discussions with this customer, management currently expects the customer's
purchases of TN grade ITO coated glass in future periods to be lower than
historical levels because the customer is in the process of installing its
own equipment to produce TN grade ITO coated glass. This equipment will have
the capacity to meet all of the customer's needs for TN grade ITO coated
glass by the second half of 1998. The customer has indicated that their
demand for STN grade ITO coated glass will increase during 1998, and have
indicated that they are interested in purchasing their STN grade ITO coated
glass from the Company once the P-2 line becomes operational. The Company has
been successful in selling all of its TN grade capacity to other customers.
Therefore, the reduction in sales to the Company's largest customer is not
expected to have a material adverse effect on the Company's results of
operations.
GROSS PROFIT (LOSS)
Gross loss was $289,360 in 1997 compared to $488,587 in 1996. The decrease
in the loss was due in part to increases in unit volumes discussed above. Cost
of sales consists of substrate costs, target material costs, labor and overhead
related to the Company's manufacturing operations. Material costs for glass
decreased in 1997, partially due to the fact that the Company's principal
customer was supplying their own glass for a majority of the year. In addition,
during the fourth quarter of 1996, the Company determined that certain glass
inventory, a portion of which the Company had successfully coated and sold
earlier in 1996, had become stained by the packaging materials. The multiple
washings which this glass required and the poor quality of output and high scrap
rates made it economically unfeasible to attempt to coat this glass. Management,
therefore, reduced the carrying value of this inventory by approximately
$400,000 and charged that amount to cost of sales in the fourth quarter of 1996.
The decrease in glass cost during 1997 was offset by increases in target
material costs, direct labor and benefits, utilities, and depreciation expense,
all of which are directly related to production volume. In total, cost of sales
12
<PAGE>
increased only 38 percent while revenues increased 51 percent, resulting in a
lower gross margin loss in 1997. During 1997, the Company continued its trend of
increasing sales and improving gross margins during each successive quarter and
the Company recorded a gross profit of nearly $300,000 in the fourth quarter of
1997 on sales of approximately $1,800,000. Management expects gross margins to
continue to improve in the future with the addition of more labor-efficient
production lines and increases in revenues as a result of anticipated changes in
product mix to higher priced STN grade products.
PROCESS AND PRODUCT DEVELOPMENT AND ENGINEERING EXPENSE
Process and product development and engineering expenses increased to
$920,088 in 1997 from $455,847 in 1996. These expenses consist of personnel
costs, consulting, testing, supplies, facilities and depreciation expenses. The
increase in 1997 was due primarily to increased personnel and facilities
expenses incurred while the Company undertook the installation and manufacturing
process development on its P-2 line. During 1996, certain of the indirect costs
associated with such equipment were capitalized as a cost of equipment being
manufactured for sale. During 1997, the equipment sale contract was
cancelled, and the P-2 line was installed in the Company's facility. Costs
incurred during 1997 related to the installation and manufacturing process
development were expensed. Also, during the third quarter of 1997, the
Company restructured a lease on certain engineering equipment as part of its
continued refocusing of the Company's operations, resulting in a loss on the
lease transaction of $49,586, which has also been recorded as an engineering
expense. The Company anticipates that product and process development and
engineering expenses will continue at approximately current levels in the
future as the Company adds productive capacity and develops its manufacturing
processes for new equipment and new products.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased to $1,971,868 in 1997 from
$1,003,365 in 1996. These expenses consist primarily of compensation expenses
for administration, finance, and general management personnel, as well as office
supplies, depreciation, bad debts and professional fees. Approximately $160,000
of the increase in 1997 is related to salaries, benefits, and hiring expenses
as a result of increased staffing, as the Company has sought to strengthen its
executive management team. The Company also incurred over $900,000 in legal,
accounting and professional fees during 1997 compared to approximately $225,000
in 1996. A portion of such fees were incurred in connection with two separate
investigations of certain transactions recorded in 1996 and prior years, which
resulted in the restatement of previously issued annual and interim financial
statements of the Company. These fees were also incurred in part as a result of
various litigation matters pending against the Company (see Item 3 - Legal
Proceedings). Additional legal fees will be incurred in connection with such
litigation matters in 1998, and such amounts may be material to the Company's
1998 results of operations.
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SELLING AND MARKETING EXPENSES
Selling expenses increased to $477,989 in 1997 from $459,281 in 1996. These
expenses consist principally of compensation costs for sales personnel,
commissions, travel expenses, trade show expenses, and freight out costs. In
1997 the Company reduced expenditures for trade shows and personnel related to
products that have been discontinued as the Company focused its operations on
the production and sale of ITO coated glass. The Company uses independent sales
representatives to sell its ITO coated glass products and a substantial portion
of its 1997 selling and marketing expenses consisted of commissions paid to
these representatives. Freight out costs increased proportionately with the
increase in unit sales in 1997.
ARBITRATION SETTLEMENT EXPENSE
In 1994, the Company entered into a joint venture agreement with the
Shenzhen WABO Group Company Limited (WABO), of Shenzhen, China. The joint
venture company, known as the Shenzhen Fortune Conductive Glass Company, Ltd.
(Fortune), was created to produce TN grade ITO coated glass for the Asian
market. The Company had agreed to sell to Fortune an ITO glass coating system
(the P-3 line) and technology limited to the production of TN grade ITO coated
glass for the net purchase price of $5,487,000. The Company had also agreed to
provide a royalty free license to Fortune for the use of certain of the
Company's proprietary technology for the production of TN grade ITO coated
glass.
During 1996, the Company was informed by WABO of their intention
to dissolve the joint venture agreement. The Company will keep the P-3
line, and plans to modify and install the line for its own use. In April 1997,
the Company received notice that arbitration proceedings had been commenced
against it by WABO, claiming damages of or reimbursement of approximately
$4,400,000 plus legal fees. A negotiated settlement of this matter was reached
in January 1998, and approved by the Chinese arbitration board in February 1998.
Under the terms of this settlement, the Company will pay WABO $1,500,000 in cash
and issue 200,000 shares of common stock to settle all claims in connection with
the joint venture contract, the equipment contract and related agreements. The
total value of this settlement is $2,425,000 based on the market value of the
Company's common stock as of January 13, 1998. The Company had previously
recorded a liability of $1,735,435 for amounts due to WABO. The balance of
$689,565 was recorded as an arbitration settlement expense in 1997.
OTHER NONRECURRING CHARGES
In connection with the 1996 cancellation of the equipment purchase contract
with WABO, the Company determined that certain equipment which was to have been
sold to the joint venture and equipment that was under development for the
Company's use was no longer economically feasible or did not fit the Company's
current manufacturing needs. This equipment, which the Company determined had no
foreseeable future value, was written off, resulting in a charge of $1,800,000
in the fourth quarter of 1996 and an additional $110,788 in the first quarter of
1997.
In the fourth quarter of 1996, the Company discontinued its development of
commercial scale production equipment for its ZeroRay-TM- glare and radiation
control filters due to technical difficulties encountered with the large scale
production of the optical gel adhesive necessary for attaching the filters to
computer and television screens. Management believes that the resolution
14
<PAGE>
of these issues would have required significant additional resources and would
have raised the cost of the filters to a point where the product could not be
competitive with other similar products. In connection with this decision,
management determined that production equipment that had been purchased to
manufacture the ZeroRay product had been impaired. The Company determined that
this equipment, which had a historical cost of approximately $378,000, had no
foreseeable future value and was, therefore, written off.
Also, in 1997, the Company determined that as a result of refocusing its
operations, a facility it had been leasing was no longer necessary. Leasehold
improvements of $34,270 were written off in connection with the termination of
the lease agreement. Equipment, which was determined to have no future value to
the Company at March 31, 1997, was written down to its fair value, resulting in
an impairment charge of $53,652.
NET INTEREST EXPENSE (INCOME)
For the year ended December 31, 1997 the Company had net interest income of
$74,842 compared to net interest expense, including amortization of debt
offering costs, of $120,353 in 1996. The change is due primarily to the fact
that the Company capitalized more interest costs into its projects
under construction in 1997. Gross interest charges were approximately $502,000
in 1997 compared to $605,000 in 1996. However, the Company capitalized
approximately $474,000 of interest into equipment under construction during 1997
compared to $229,000 capitalized in 1996.
LOSS ON LEASE DEFAULT
During the fourth quarter of 1997, the Company defaulted on certain leases,
including the sale-leaseback financing of the P-3 line. Under the
terms of the leases, in the event of a default, the Company can be required to
immediately pay all future lease payments under the lease. Subsequent to
December 31, 1997, the lessor demanded payment of such amounts and has requested
the trustee holding the $2,250,000 in marketable securities which were being
held as a compensating balance to liquidate the securities and forward the
proceeds to the lessor in partial payment of amounts owed by the Company. The
total of all future lease payments exceeds amounts previously recorded in the
financial statements by approximately $900,000, and a loss representing this
additional liability was recorded in the fourth quarter of 1997. The Company
is attempting to refinance these leases and management anticipates that this
issue will be resolved during the second quarter of 1998.
EXTRAORDINARY ITEM
Upon repayment of the Company's Bridge Notes in June 1996, the remaining
unamortized balance of $71,990 in deferred financing fees was written off. The
loss on extinguishment has been classified as an extraordinary item in the
statement of operations for the year ended December 31, 1996.
NET LOSS PER COMMON SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 128, EARNINGS PER SHARE. This
Statement replaces the presentation of primary and fully diluted EPS with a
presentation of basic and diluted EPS,
15
<PAGE>
respectively. Basic EPS excludes dilution and is computed by dividing income
(loss) available to common stockholders by the weighted-average number of common
shares outstanding for the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock that then shared in the earnings of the entity. SFAS No. 128 requires the
restatement of prior periods to conform to the new computational guidelines.
Basic and diluted earnings per share are the same because all contingently
issuable shares are antidilutive. All per share amounts for 1996 and the
first three quarters of 1997 have been restated to follow the new
computational requirements. The effect of this restatement on the net loss
per share for 1996 was an increase from ($1.13) per share to ($1.15) per
share.
NET OPERATING LOSS CARRYFORWARDS
In accordance with Section 382 of the Internal Revenue Code of 1986, as
amended (the Code), a change in ownership of greater than 50 percent of the
Company within a three year period results in an annual limitation on the
Company's ability to utilize its net operating loss (NOL) carryforwards which
accrued during the tax periods prior to the change in ownership. As of December
31, 1997, the Company had an NOL carryforward of approximately $11,900,000 which
expires in 2006 through 2012. Due to certain ownership changes which occurred
during the year ended December 31, 1993, the NOL carryforwards of $700,000
incurred through February 1993, which can be utilized by the Company on an
annual basis, are limited to approximately $50,000. The annual limitation may be
increased for any built-in gains recognized within five years of the date of the
ownership change. Utilization of the approximately $11,200,000 of NOL
carryforwards incurred after February 1993 is not limited under Section 382 of
the Code. However, the Company's ability to use its NOL carryforwards may be
further limited by subsequent issuances of common stock.
LIQUIDITY AND CAPITAL RESOURCES
The Company has incurred accumulated losses since its inception of
$14,726,065 and incurred negative cash flows from operating activities of
$1,531,165 for the year ended December 31, 1997. The Company had cash outlays
for property and equipment additions of $3,612,885 for the year ended December
31, 1997.The Company's continuation as a going concern is dependent on its
ability to meet its obligations as they become due. The Company's financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amounts and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern. Management's plans regarding operating losses and its plans
concerning the above matters are presented in the Outlook section below.
As of December 31, 1997, the Company was in default on a shareholder note
payable of $1,100,000 and certain leases aggregating approximately $5,400,000,
including the sale-leaseback transaction on the Company's P-3 production line.
In February 1998, the Company cured the default on the shareholder note, and
restructured the note to extend its maturity date to February 2002 (see Notes 4
and 10 to the financial statements). The Company has not resolved the
default on the lease transactions. Under the terms of the leases, in the event
of a default, the Company can be required to immediately pay all future lease
payments due under the lease. The total of such payments exceeded amounts
previously recorded in the financial statements by approximately $900,000.
Subsequent to December 31, 1997 the lessor demanded payment of such amounts.
This additional liability was recorded in the fourth quarter of 1997. The
Company is attempting to negotiate a settlement of these lease obligations
at amounts less than the recorded amounts. Settlement of the lease defaults
will require new financing. The Company is in discussions with prospective
lenders to provide the new credit facility to fund the settlement of the
defaulted lease obligations. Management expects to complete the settlement
negotiations and obtain new financing arrangements during the second quarter
of 1998. However, no assurance can be given that management will be able to
negotiate an acceptable settlement or, if the Company is successful in
negotiating an acceptable settlement, that the financing necessary to
extinguish the obligations will be available, or be available on terms
acceptable to the Company.
As of December 31, 1997, the Company's principal sources of liquidity
included cash and cash equivalents of $46,107, net accounts receivable of
$722,113 and an $833,000 working capital line of credit obtained in December
1997. Assuming the Company refinances the leases that are in default at
December 31, 1997, management believes that its existing sources of liquidity
and anticipated funds from operations, combined with the net proceeds from a
first quarter 1998 private debt placement of $3,500,000, will satisfy the
Company's projected working capital and capital expenditure requirements for
1998.
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<PAGE>
The net cash used in operating activities for 1997 was $1,531,165, due
principally to the net loss for the year of $5,323,756 which was partially
offset by non-cash charges for depreciation, the arbitration settlement loss,
and the loss on the lease default, as well as a significant increase in the
Company's accounts payable.
The net cash used in operating activities for 1996 was $1,478,877 due
principally to the net loss of $4,816,317 which was partially offset by
non-cash charges for depreciation and asset impairment losses. Expenditures
for equipment held for sale were 895,390, offset by the receipt of a $500,000
down payment. In 1996, the Company entered into an agreement to sell ITO coating
equipment to its largest customer for a total contract price of $2,916,500. The
Company received a down payment of $500,000 in 1996 which was recorded as a
customer advance. Delivery of the equipment was originally scheduled for the
fourth quarter of 1996. This delivery was delayed, and in June of 1997, the
Company reached an agreement with the customer whereby the Company will keep the
coating equipment and refund the down payment (plus interest of approximately
$40,000) via credits against future glass purchases.
Cash used in investing activities was $5,862,885 during 1997 compared to
$8,896,744 in 1996. In both periods this cash was used primarily for the
purchase of equipment and leasehold improvements. In 1996, expenditures related
to the equipment intended for sale to the Company's China joint venture have
been categorized as additions to property and equipment due to the cancellation
of the equipment purchase agreement and the Company's decision to use this
equipment as an additional manufacturing line. Internal costs, consisting
primarily of direct labor and supplies used in the construction of equipment, of
approximately $2,260,000 and $2,470,000 and interest costs of $474,000 and
$229,000 were capitalized to construction-in progress during 1997 and 1996,
respectively. In 1997, the Company also used $2,250,000 to purchase
marketable securities which are restricted as a compensating balance on the
sale-leaseback financing of the Company's P-3 line. Subsequent to December
31, 1997, in connection with its demand for payment of all remaining lease
payments, the lessor has requested the trustee holding such securities to
liquidate the account and forward the proceeds to the lessor in partial
payment of amounts owed by the Company.
Cash flows from financing activities during the year ended December 31,
1996 consisted primarily of approximately $18,500,000 in proceeds from the
Company's initial public stock offering in May 1996. Following the offering, the
Company repaid $4,000,000 of Bridge Notes together with approximately $287,500
in accrued interest and a loan from a director of $1,166,668. The Company also
repaid a $2,000,000 EXIM secured bank line of credit from the
17
<PAGE>
proceeds of the offering to reduce interest payments and to avoid payment of
EXIM renewal fees. In February 1997, the Company obtained $4,500,000 in a
sale-leaseback treated as a financing transaction of the P-3 production line.
This lease is currently in default as discussed above. In September and
November 1997, the Company obtained a loan from a shareholder totalling
$1,100,000. In December 1997, the Company obtained an $833,000
transaction-specific export working capital line of credit, although there
were no borrowings against the line in 1997.
OUTLOOK
During 1997 the Company installed a new management team consisting of its
new President and new Vice Presidents for Finance, Technology, and
Manufacturing. The new management team, together with the Company's Board of
Directors, has taken several steps to refocus the Company's efforts. The Company
terminated several engineering projects that did not directly relate to the
installation of additional coating equipment at the Company's facilities. In an
effort to focus all of the Company's personnel on manufacturing activities and
the development and refinement of core deposition technologies, in March of 1997
the Company also terminated 21 employees, and reassigned several others. In
addition, restructuring of manufacturing shifts and process modifications made
to the P-1 line have resulted in a significant increase in production output.
Moreover, the Company has expanded its customer base and reduced its dependence
on a single customer.
In 1997 the Company's management and board spent a significant portion of
its time and efforts investigating irregularities allegedly perpetrated by its
former president, restating its financial statements, and addressing matters
relevant to the joint venture arbitration, the SEC investigation, the securities
class action litigation, and the litigation with the former president. The
Company has completed the very detailed and exhaustive investigation and the
restatement of its financial statements to reflect the results of the
investigation. In addition, the Company has reached a favorable settlement
with its former joint venture partner and obtained the resources to fund that
settlement. In 1998 the Company expects management to continue to devote
time and resources to the resolution of ongoing legal matters.
Based on discussions with customers, independent sales representatives and
glass suppliers, the Company believes that the strong demand for its ITO coated
glass will continue in 1998. The Company is continuing to work on the
development of additional products for introduction in 1998, however, management
expects that TN grade ITO coated glass sales will continue to generate the
majority of the Company's revenues in 1998.
The Company's ability to install new production equipment has been limited
by access to capital. In addition, design and technological issues have delayed
the startup of the P-2 line. In the first quarter of 1998 the Company closed on
the private placement of convertible debt for $3,500,000. The Company has
recruited new engineering talent and restructured its engineering department.
Management believes that it now has the resources to complete the installation
of the P-2 and P-3 coating lines in 1998.
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OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
The Company's future operating results may fluctuate significantly due to
factors such as the timing of new product announcements and introductions by the
Company, its major customer and its competitors, market acceptance of new or
enhanced versions of the Company's products, changes in the product or customer
mix, changes in the level of operating expenses, inventory obsolescence and
asset impairments, competitive pricing pressures, the gain or loss of
significant customers, the vertical integration of its customers, increased
product and process development costs associated with new product introductions,
the timely completion of construction and installation and the actual
performance of new manufacturing equipment, the Asian economic crisis, the
outcome of pending litigation and refinancing negotiations, and general economic
conditions. All of the above factors are difficult for the Company to forecast,
and these or other factors may materially adversely affect the Company's
business and operating results for one quarter or a series of quarters. The
Company's current expense levels are based in part on its expectations regarding
future revenues and in the short term are fixed to a large extent. Therefore,
the Company may be unable to adjust spending in a timely manner to compensate
for any unexpected revenue shortfall. Accordingly, any significant decline in
demand relative to the Company's expectations or any material delay of customer
orders would have a material adverse effect on the Company's financial
condition, cash flows, and operating results.
YEAR 2000 DISCLOSURES
As is the case with most other companies using computers in their
operations, the Company is in the process of addressing the Year 2000 problem.
The Company's accounting and manufacturing systems include new hardware which is
Year 2000 compliant and packaged software purchased from large vendors who have
indicated that there are updates available to these systems which are Year 2000
compliant. During 1998 the Company plans to purchase such software updates and
perform tests to verify that these assertions are true. The Company does not
have electronic data interchange (EDI) relationships with any of its vendors or
customers, with the exception of its payroll disbursement function. The Company
is in the process of initiating formal communications with all of its
significant suppliers and large customers to determine the extent to which the
Company is vulnerable to those third parties failure to remediate their own Year
2000 issues. The Company can give no guarantee that the systems of other
companies on which the Company's systems rely will be converted on time or that
a failure to convert by another company or a conversion that is incompatible
with the Company's systems, would not have a material adverse effect on the
Company. The total cost to the Company of these Year 2000 compliance activities
has not been and is not anticipated to be material to its financial position or
results of operations in any given year.
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ITEM 7 - FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
Page
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . . . 21
Balance Sheets as of December 31, 1996 and 1997. . . . . . . . . . . . . . . 22
Statements of Operations for the years ended December 31, 1996 and
1997. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Statements of Shareholders' Equity for the years ended December 31,
1996 and 1997. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Statements of Cash Flows for the years ended December 31, 1996 and
1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Notes to Financial Statements for the years ended December 31,
1996 and 1997. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
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INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Photran Corporation
Lakeville, Minnesota
We have audited the accompanying balance sheets of Photran Corporation (the
Company) as of December 31, 1996 and 1997 and the related statements of
operations, shareholders' equity, and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of Photran Corporation as of December 31, 1996
and 1997 and the results of its operations and its cash flows for the years then
ended, in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company's cumulative losses of $14,726,065 since
incorporation, negative cash flows from operating activities of $1,531,165
for the year ended December 31, 1997, and working capital deficiency of
$7,413,386 at December 31, 1997 raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans concerning these
matters are described in Note 1. These financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
March 25, 1998
21
<PAGE>
PHOTRAN CORPORATION
BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
1996 1997
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,038,955 $ 46,107
Accounts receivable, net 544,340 722,113
Inventory 754,572 387,000
Equipment held for sale (Note 2) 907,812
Prepaid expenses 109,540 37,814
Marketable securities, restricted 2,250,000
------------ ------------
Total current assets 4,355,219 3,443,034
------------ ------------
------------ ------------
PROPERTY AND EQUIPMENT, net (Note 3) 14,927,174 18,535,149
------------ ------------
$ 19,282,393 $ 21,978,183
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt,
notes payable and capital lease
obligations (Note 4) $ 51,592 $ 5,613,143
Accounts payable 663,411 1,804,846
Accrued expenses 758,915 713,893
Customer advances (Note 2) 2,260,420 2,034,973
Arbitration settlement payable (Note 2) 689,565
------------ ------------
Total current liabilities 3,734,338 10,856,420
LONG-TERM DEBT AND CAPITAL LEASE
OBLIGATIONS, less current portion (Note 4) 327,813 1,023,653
------------ ------------
Total liabilities 4,062,151 11,880,073
COMMITMENTS AND CONTINGENCIES (Note 6)
SHAREHOLDERS' EQUITY (Notes 4 and 7):
Undesignated stock, no par value -
6,000,000 shares authorized, no shares
issued and outstanding
Common stock, no par value - 24,000,000
shares authorized, 5,154,392 and
5,230,303 shares issued and
outstanding, respectively 24,622,551 24,824,175
Accumulated deficit (9,402,309) (14,726,065)
------------ ------------
Total shareholders' equity 15,220,242 10,098,110
------------ ------------
$ 19,282,393 $ 21,978,183
------------ ------------
------------ ------------
</TABLE>
See notes to financial statements.
22
<PAGE>
PHOTRAN CORPORATION
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
1996 1997
------------ ------------
<S> <C> <C>
REVENUES $ 2,904,460 $ 4,382,600
COST OF SALES 3,393,047 4,671,960
------------ ------------
Gross loss (488,587) (289,360)
OPERATING EXPENSES:
Process and product development and engineering 455,847 920,088
General and administrative 1,003,365 1,971,868
Selling and marketing 459,281 477,989
Arbitration settlement (Note 2) 689,565
Other nonrecurring charges (Note 8) 2,216,894 198,710
------------ ------------
Total operating expenses 4,135,387 4,258,220
------------ ------------
LOSS FROM OPERATIONS (4,623,974) (4,547,580)
INTEREST EXPENSE (INCOME), net 120,353 (74,842)
LOSS ON LEASE DEFAULT 902,602
OTHER EXPENSE (INCOME) (51,585)
------------ ------------
LOSS BEFORE EXTRAORDINARY ITEM (4,744,327) (5,323,756)
EXTRAORDINARY ITEM-loss on
extinguishment of debt (Note 1) (71,990)
------------ ------------
NET LOSS $ (4,816,317) $ (5,323,756)
------------ ------------
------------ ------------
BASIC AND DILUTED LOSS PER COMMON SHARE
(Notes 1 and 7):
Loss before extraordinary item $ (1.13) $ (1.03)
Extraordinary item (0.02)
------------ ------------
Net loss $ (1.15) $ (1.03)
------------ ------------
------------ ------------
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING (Notes 1 and 7) 4,169,171 5,174,108
------------ ------------
------------ ------------
</TABLE>
See notes to financial statements.
23
<PAGE>
PHOTRAN CORPORATION
STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK TOTAL
------------------------- ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT DEFICIT EQUITY
---------- ----------- ------------ -------------
<S> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995 2,837,323 $ 6,133,847 $ (4,585,992) $ 1,547,855
Common stock issued in
connection with initial public
offering, net of offering
costs of $2,248,372 2,300,000 18,451,628 18,451,628
Common stock issued upon
exercise of warrants 17,069 37,076 37,076
Net loss (4,816,317) (4,816,317)
---------- ----------- ------------ -----------
BALANCE AT DECEMBER 31, 1996 5,154,392 $24,622,551 $ (9,402,309) $15,220,242
Common stock issued upon exercise of
options and warrants 74,506 149,324 149,324
Common stock issued in lieu of
compensation 1,405 6,500 6,500
Value of warrants issued (Note 7) 45,800 45,800
Net loss (5,323,756) (5,323,756)
---------- ----------- ------------ -----------
BALANCE AT DECEMBER 31, 1997 5,230,303 $24,824,175 $(14,726,065) $10,098,110
---------- ----------- ------------ -----------
---------- ----------- ------------ -----------
</TABLE>
See notes to financial statements.
24
<PAGE>
PHOTRAN CORPORATION
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Loss before extraordinary item $(4,744,327) $(5,323,756)
Adjustments to reconcile loss before extraordinary
item to cash used in operating activities:
Depreciation and amortization of property
and equipment 622,707 999,847
Loss on impairment of fixed and other assets 2,223,283
Amortization of deferred financing costs 120,000
Non-cash arbitration settlement expense 689,565
Accrual of loss on lease default 902,602
Non-cash loss on lease restructuring 49,586
Non-cash compensation and consulting expense 18,500
Changes in current assets and liabilities that
provided (used) cash:
Accounts receivable 159,129 (417,740)
Inventory 665,476 367,572
Equipment held for sale (895,390)
Prepaid expenses (95,013) 71,726
Accounts payable (532,421) 1,141,434
Accrued expenses 497,694 (30,502)
Customer advances 499,985
----------- -----------
Cash used in operating activities (1,478,877) (1,531,165)
CASH FLOWS FROM INVESTING ACTIVITIES:
Property and equipment additions (8,896,744) (3,612,885)
Purchases of marketable securities, restricted (2,250,000)
----------- -----------
Cash used in investing activities (8,896,744) (5,862,885)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable, long-term debt and capital leases 5,600,000
Payments of notes payable, long-term debt and capital leases (7,606,489) (348,122)
Common stock issued net of offering costs
of $2,248,372 in 1996 18,488,704 149,324
----------- -----------
Cash provided by financing activities 10,882,215 5,401,202
----------- -----------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 506,594 (1,992,848)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 1,532,361 2,038,955
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 2,038,955 $ 46,107
----------- -----------
----------- -----------
</TABLE>
See notes to financial statements.
25
<PAGE>
PHOTRAN CORPORATION
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1997
1. BUSINESS, MANAGEMENT'S PLANS REGARDING OPERATING LOSSES AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
BUSINESS - Photran Corporation (the Company) is engaged in the manufacture
and sale of products incorporating thin film coatings which consist of
microscopic layers of metal and metal oxide materials. Materials coated with
these thin film coatings are components in a wide variety of products, including
liquid crystal displays, enhanced reflection mirrors and anti- reflective glass.
To date, the Company's sales have consisted of coated glass products to a
limited number of companies located in Asian countries for use in liquid crystal
displays.
MANAGEMENT'S PLANS REGARDING OPERATING LOSSES
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The Company has incurred
cumulative losses aggregating $14,726,065 since its inception and
incurred negative cash flows from operating activities of $1,531,165 for the
year ended December 31, 1997. In addition, at December 31, 1997, the Company
had a working capital deficiency of $7,413,386. These factors, among others,
indicate the Company may be unable to continue as a going concern for a
reasonable period of time.
26
<PAGE>
The financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts
and classification of liabilities that might be necessary should the Company
be unable to continue as a going concern. As described in Note 4, at December
31, 1997, the Company was not in compliance with the terms of two lease
agreements and has been unable to cure or obtain waivers for the defaults.
Accordingly, the balance of these lease obligations (approximately
$5,400,000) has been classified as a current liability. In addition, as
described in Note 6, the Company is currently under investigation by the
Securities and Exchange Commission (SEC), and is the defendant in a number of
legal actions. Significant management time and financial resources will
likely be required to defend the Company in these matters.
The Company's continuation as a going concern is dependent on its
ability to generate sufficient cash flow to meet its obligations including
legal defense costs, which could be significant, on a timely basis, to comply
with the terms and conditions of its financing agreements, to obtain
additional financing or refinancing as may be required, to achieve acceptable
resolutions of the defaulted lease obligations, the SEC investigation and the
various other legal actions and ultimately attain sales and operating levels
sufficient to support its cost structure.
Management is continuing its efforts to obtain additional funds so the
Company can meet its obligations and sustain its operations. As of December
31, 1997, the Company's principal sources of liquidity included cash and cash
equivalents of $46,107 and net accounts receivable of $722,113, as well as an
$833,000 transaction-specific working capital line of credit against which
there were no borrowings outstanding as of year end. The Company believes
that its existing sources of liquidity and anticipated funds from operations,
combined with the net proceeds from a $3,500,000 first quarter 1998 private
debt placement (see Note 10), will satisfy the Company's projected working
capital and capital expansion requirements for 1998, as well as fund the
$1,500,000 cash obligation under the settlement reached with the Company's
former joint venture partner (see Note 2). The Company will, however, require
additional debt or equity financing to resolve the defaults on certain of its
leases. In addition, if the remaining expenditures required to complete the
additional coating lines significantly exceeds the Company's estimates, the
Company may need to seek additional debt or equity financing. There can be no
assurance that the necessary financing will be available or be available on
terms acceptable to the Company.
SIGNIFICANT ACCOUNTING POLICIES
MANAGEMENT'S USE OF ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
27
<PAGE>
REVENUE RECOGNITION - Revenues for coated glass sales are recognized upon
shipment of products to customers.
REVENUE FROM SIGNIFICANT CUSTOMERS - Substantially all of the Company's
sales for the years ended December 31, 1996 and 1997 were to customers located
in Asian countries. The percentages of total revenue from sales to customers in
excess of 10 percent of the total for each year were as follows:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Customer A 82% 54%
Customer C --- 24
Customer D --- 13
</TABLE>
PROCESS AND PRODUCT DEVELOPMENT AND ENGINEERING - Expenditures for
research and development of products and manufacturing processes are expensed
as incurred. During 1996, certain of the indirect costs associated with
building equipment were charged to construction in progress as a cost of
equipment being manufactured for sale. During 1997, the equipment sale
contract was cancelled, and the equipment was installed in the Company's
facility. Costs incurred in 1997 during installation and manufacturing
process development were expensed.
CASH AND CASH EQUIVALENTS - The Company considers all highly liquid
investments purchased with an original maturity of three months or less to be
cash equivalents.
ACCOUNTS RECEIVABLE - The Company's accounts receivable at December 31,
1996 and 1997 are due primarily from foreign customers located in Asian
countries. The Company normally requires the establishment of irrevocable
letters of credit in its favor from approved banks prior to shipment of the
products underlying these accounts receivable in order to reduce its exposure to
bad debts. At December 31, 1996 and 1997, $338,000 and $588,000, respectively,
of accounts receivable from foreign customers were not secured by letters of
credit. These accounts were due from customers with whom the Company has had a
creditor relationship for over one year.
The percentage of gross receivables due from customers in excess of 10
percent of the December 31 balance is as follows:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Customer A 43% --
Customer B 54 --
Customer C 98%
</TABLE>
INVENTORY - Inventory is valued at the lower of cost, determined on the
first-in, first-out method, or market value. Inventory at December 31 consists
of the following:
28
<PAGE>
<TABLE>
<CAPTION>
1996 1997
---------- --------
<S> <C> <C>
Raw materials and supplies $1,117,569 $562,254
Finished goods 34,892 65,355
---------- --------
1,152,461 627,609
Less: obsolescence reserve 397,889 240,609
---------- --------
Net inventory $ 754,572 $387,000
---------- --------
---------- --------
</TABLE>
Inventories are periodically reviewed for obsolescence, overstock, and
quality defects by physical examination and by comparing quantities on hand to
forecasted future requirements. Items considered obsolete or overstock are
written off. Items with quality defects are valued at net realizable value. In
the fourth quarter of 1996, the Company determined that certain glass inventory,
a portion of which the Company had successfully coated and sold earlier in 1996,
had become stained by the packaging materials. The multiple washings which this
glass required and the poor quality of output and high scrap rates made it
economically unfeasible to attempt to coat this glass. Management had
established an obsolescence reserve of $397,889, which has been charged to cost
of sales in the fourth quarter of 1996 to reduce the carrying value of this
glass to its estimated net realizable value if sold as uncoated scrap. No
additional reserve was deemed necessary during 1997, and as of December 31,
1997, this reserve has been reduced to $240,609 because a portion of this
glass was sold during 1997.
The Company purchases substantially all of its raw glass, which is the
majority of the raw materials used in the manufacture of its products, from a
single source supplier. The Company believes that acceptable alternative sources
of this material are available. During 1997, the Company began purchasing glass
from a second supplier.
EQUIPMENT HELD FOR SALE - Equipment held for sale at December 31, 1996 was
carried at cost, including $17,000 of capitalized interest. During 1997, this
equipment was transferred to construction-in-progress (see Note 2).
MARKETABLE SECURITIES - Marketable securities consist of short-term U.S.
government obligations and bear interest at 5.1 percent. These securities are
restricted as a compensating balance on the $4,500,000 sale-leaseback financing
of the P-3 production line (see Note 4).
PROPERTY AND EQUIPMENT - Property and equipment are recorded at cost. Cost
includes expenditures for new equipment and incremental labor and direct costs
incurred for construction of equipment modifications. Property and equipment
includes approximately $209,000 and $474,000 of interest capitalized during the
years ended December 31, 1996 and 1997 respectively. Property, other than
manufacturing process equipment, is depreciated using the straight-line method
over estimated useful lives of three to ten years. Manufacturing process
equipment is depreciated using the units-of-production method, with such
equipment's useful life estimated to be approximately ten years. Amortization of
equipment under capital leases is over the shorter of the lease term or the
economic useful life and is recorded as depreciation expense. Depreciation is
not recorded on property not yet placed in service. Repairs and maintenance are
charged to expense as incurred.
29
<PAGE>
IMPAIRMENT OF LONG-LIVED ASSETS - Management periodically reviews the
carrying value of property and equipment and other long-lived assets for
potential impairment by comparing its carrying value to the estimated
undiscounted future cash flows expected to result from the use or disposal of
these assets. Should the sum of the related expected future net cash flows be
less than the carrying value, an impairment loss is recognized. An impairment
loss is measured by the amount by which the carrying value of the asset exceeds
the fair value of the asset.
As of December 31, 1996, the Company reassessed the carrying values of the
fixed assets related to several production projects in relation to the expected
future cash flows from sales of the manufactured products. The Company decided
that it would refocus its efforts with respect to such projects and would not
pursue those for which commercial production did not appear feasible in the near
term. The related fixed assets were, therefore, written down to their estimated
fair values, which in some cases were determined by their historical cost less a
restocking fee to the extent that the Company could return purchased components
to the manufacturer (see Note 8).
The value of certain license rights was deemed impaired as of December 31,
1996, and the costs were written off. These charges are included in other
nonrecurring charges in the statements of operations.
CUSTOMER ADVANCES - Customer advances represent amounts received from
customers as down payments on equipment contracts. (See Note 2).
INCOME TAXES - The Company calculates income taxes in accordance with the
provisions of Statement of Financial Accounting Standards (SFAS) No. 109,
ACCOUNTING FOR INCOME TAXES. SFAS No. 109 requires an asset and liability
approach to financial accounting and reporting for income taxes. Deferred income
tax assets and liabilities are computed annually for differences between the
financial statement and tax basis of assets and liabilities that will result in
taxable or deductible amounts in the future based on enacted tax laws and rates
applicable to the period in which the differences are expected to affect taxable
income.
NET LOSS PER COMMON SHARE - In February 1997, the Financial Accounting
Standards Board issued SFAS No. 128, EARNINGS PER SHARE. This statement
replaces the presentation of primary and fully diluted earnings per share
(EPS) with a presentation of basic and diluted EPS, respectively. Basic EPS
excludes dilution and is computed by dividing income (loss) available to
common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity. SFAS No. 128
requires the restatement of prior periods to conform to the new computational
guidelines. Accordingly, all per share amounts within these financial
statements have been restated to comply with the new computational
requirements. The effect of applying the new computational guidelines for
1996 was an increase from ($1.13) per share to ($1.15) per share.
30
<PAGE>
Basic net loss per common share is computed by dividing net loss by the
weighted average number of common stock outstanding. Diluted net loss per share
is equal to basic net loss per share as common stock equivalents (consisting of
stock options and warrants) are excluded from the computation because their
effect is anti-dilutive.
STOCK-BASED COMPENSATION - SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, requires expanded disclosures of stock-based compensation
arrangements with employees and encourages (but does not require) application of
the fair value recognition provisions of SFAS No. 123 to such arrangements.
The Company has chosen to continue to account for stock-based
compensation with employees using the intrinsic value method prescribed in
Accounting Principles Board (APB) Opinion No. 25, ACCOUNTING FOR STOCK ISSUED
TO EMPLOYEES, and related interpretations. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the quoted market price
of the Company's stock at the date of the grant over the amount an employee
must pay to acquire the stock. (See Note 7).
EXTRAORDINARY ITEM - The unamortized balance of deferred financing costs
was written off upon repayment of the Bridge Notes in 1996, and has been
classified as an extraordinary item in the 1996 statement of operations.
FINANCIAL RISKS AND UNCERTAINTIES - The Company has disclosed in the
financial statements certain financial risks and uncertainties to which it is
subject: concentration of sales to a limited number of customers; few suppliers
of raw materials; and use of estimates to review the carrying value of long-
lived assets which may change in the future given the rapid technological
changes associated with the industry in which the Company operates. The
technology used in the Company's manufacturing equipment may be subject to rapid
technological change within time frames not currently anticipated by the
Company. It is reasonably possible that the Company's estimate of recoverability
of the carrying value of its equipment will change in the future.
2. EQUIPMENT CONTRACTS AND EQUIPMENT HELD FOR SALE
In 1994, the Company entered into a joint venture agreement with the
Shenzhen WABO Group Company, Limited (WABO) of Shenzhen, China. The joint
venture company, known as the Shenzhen Fortune Conductive Glass Company, Ltd.
(Fortune), was created to produce TN-grade ITO-coated glass for the Asian
market.
WABO provided cash to Fortune to purchase a glass coating system from the
Company and for working capital purposes. The Company was accounting for the
sale of the glass coating system using the completed contract method and
recorded a down payment received from WABO of approximately $1,735,000 as a
customer advance.
The equipment was never shipped. During the quarter ended December 31,
1996, the Company was informed by WABO of their intention to dissolve the joint
venture and cancel the
31
<PAGE>
related equipment purchase contract. While the Company has determined that
certain write-downs were necessary as a result of the termination of this
purchase contract (see Note 8), the Company intends to keep the glass coating
system, which was a part of the equipment which was to have been sold to
Fortune, and is currently in the process of modifying the system for its own
use. All costs incurred for the machine are classified as
construction-in-progress at December 31, 1996 and 1997. In April 1997, the
Company received notice that arbitration proceedings had been commenced
against it by WABO, claiming approximately $4,400,000 plus legal fees and
costs. In January 1998, the Company and WABO negotiated a settlement which
was approved by the Chinese arbitration board in February 1998. Under the
terms of this settlement, the Company will pay WABO $1,500,000 in cash and
issue 200,000 shares of common stock to settle all claims in connection with
the joint venture contract, the equipment contract and related agreements.
The estimated cost of this settlement is approximately $2,425,000 based on
the market value of the Company's common stock as of January 13, 1998. Of the
$2,425,000 total, $1,735,435 is included in customer advances as of December
31, 1996 and 1997. The balance of $689,565 was recorded as an arbitration
settlement expense during the year ended December 31, 1997.
In 1996, the Company entered into an agreement to sell ITO coating
equipment to its largest customer for a total contract price of $2,916,500. The
Company received a down payment of $500,000 which is recorded as a customer
advance at December 31, 1996. Delivery of the equipment was originally scheduled
for the fourth quarter of 1996. This delivery was delayed, and the customer had
requested the Company to install and operate the equipment in the Company's
facilities during 1997. Costs incurred through December 31, 1996 are classified
as equipment held for sale as of December 31, 1996. During the second quarter of
1997, the Company reached an agreement with the customer whereby the Company
will keep the equipment and refund the deposit previously received (plus accrued
interest) through credits against future glass purchases by the customer. The
cost of this equipment has been reclassified to construction-in-progress at
December 31, 1997.
3. PROPERTY AND EQUIPMENT
Property and equipment at December 31 consist of the following:
<TABLE>
<CAPTION>
Estimated
Useful Lives
in Years 1996 1997
------------ ----------- -----------
<S> <C> <C> <C>
Leasehold improvements Up to 10 $ 1,676,037 $ 2,217,790
Manufacturing process equipment 10 5,589,383 6,482,779
Construction-in-progress N/A 6,982,866 9,954,824
Other manufacturing equipment 7 1,413,892 1,556,640
Fixtures 3-7 402,791 447,461
----------- -----------
16,064,969 20,659,493
Less accumulated depreciation and amortization 1,137,795 2,124,345
$14,927,174 $18,535,149
----------- -----------
----------- -----------
</TABLE>
Manufacturing process equipment, other manufacturing equipment, and
fixtures includes assets under capital lease at costs of $312,632 and $378,094
and accumulated amortization of $79,665 and $131,012 at December 31, 1996 and
1997, respectively. Coating equipment valued
32
<PAGE>
at approximately $5,626,000 and included in construction-in-progress is the
subject of a sale-leaseback agreement which has been accounted for as a
financing transaction (see Note 4).
4. NOTES PAYABLE, LONG-TERM DEBT, AND CAPITAL LEASE OBLIGATIONS
Notes payable, long-term debt, and capital lease obligations at December 31
consist of the following:
<TABLE>
<CAPTION>
1996 1997
-------- ----------
<S> <C> <C>
Shareholder notes payable (A) $200,000 $1,270,200
Sale-leaseback financing (B) 5,098,534
Capital lease obligations (C) 179,405 268,062
-------- ----------
379,405 6,636,796
Less current maturities 51,592 5,613,143
-------- ----------
Long-term debt $327,813 $1,023,653
-------- ----------
-------- ----------
</TABLE>
The carrying amounts of long-term debt approximate fair market value on
December 31, 1996 and 1997, respectively. Rates currently available to the
Company for debt with similar terms and remaining maturities are used to
estimate the fair value of the existing debt.
(A) These notes are payable to a shareholder who is also a director. The
$200,000 shareholder note payable bears interest at 10 percent, is unsecured,
and is convertible, at the shareholder's option, into shares of the Company's
common stock at a conversion rate of $2.00 per share. In January 1998, the
shareholder who holds the note extended the due date of such note to January
1999. In connection with the issuance of this $200,000 note, warrants were
issued to the shareholder to purchase up to 20,000 shares of the Company's
common stock, exercisable from August 1994 to August 1998, at an exercise
price of $2.00 per share. Interest payable on this note was $67,500 and
$87,500 at December 31, 1996 and 1997, respectively. In September 1997, the
Company entered into a loan agreement with the shareholder, whereby the
shareholder loaned the Company an additional $1,000,000. The loan bears
interest at 3.5 percent over the reference rate, as defined (8.5 percent at
December 31, 1997), and is payable in monthly installments through September
1999. In connection with the loan, the Company issued to the shareholder
warrants for the purchase of 100,000 shares of the Company's common stock at
a price of $5.00 per share. The warrants are exercisable between September
1998 and September 2007. In November 1997, the loan was increased by
$100,000, and warrants to purchase an additional 10,000 shares of common
stock at $4.00 per share were issued. The value of the warrants has been
deducted from the principal of the loan and recorded as a discount on debt
issued (see Note 7). The shareholder notes payable are secured by an interest
in substantially all of the fixed assets of the Company, except the P-3 line.
(B) In February 1997, the Company entered into a sale-leaseback, which was
treated as a financing transaction, for the coating equipment in construction-
in-progress that was originally intended to be sold to Fortune. Under the terms
of the agreement, the Company received proceeds of $4,500,000 of which
$2,250,000 was invested in short-term U.S. government obligations as a
compensating balance.
33
<PAGE>
(C) Capital lease obligations are secured by the underlying property and
bear interest at effective interest rates of approximately 7.8 percent to 15.7
percent.
In October 1997, the Company was unable to continue to make payments on
the shareholder note and certain of its lease obligations. As of December 31,
1997, the Company was in default on the $1,100,000 shareholder loan and two
leases which aggregated approximately $5,400,000, including the sale-lease
back transaction on the Company's P-3 line. In February 1998, the Company
cured the default on the shareholder loan by paying all principal and
interest that was in arrears. The Company also renegotiated the loan, such
that the term of the loan has been extended to February 2002. Based on curing
the default and extending the term of the loan, the Company has classified
the principal amount as current and long-term in accordance with the new
payment schedule through February 2002. The Company has not yet resolved the
defaults on the lease transactions. Under the terms of the leases, in the
event of a default, the Company can be required to immediately pay all future
lease payments under the lease. The total of such payments exceeds amounts
previously recorded in the financial statements by approximately $900,000,
and this additional liability has been recorded in the fourth quarter of
1997. Subsequent to December 31, 1997, the lessor demanded payment of such
amounts and has requested the trustee holding the $2,250,000 in marketable
securities which were being held as a compensating balance to liquidate the
account and forward the proceeds to the lessor in partial payment of amounts
owed by the Company. The Company is attempting to negotiate a settlement of
these lease obligations at amounts less than the recorded amounts. Settlement
of the lease defaults will require new financing. The Company is in
discussions with prospective lenders to provide the new credit facility to
fund the settlement of the defaulted lease obligations. Management expects to
complete the settlement negotiations and obtain new financing arrangements
during the second quarter of 1998. However, no assurance can be given that
management will be able to negotiate an acceptable settlement or, if the
Company is successful in negotiating an acceptable settlement, that the
financing necessary to extinguish the obligations will be available, or be
available on terms acceptable to the Company. The entire principal balances
of these leases have been classified as current liabilities at December 31,
1997. The compensating balance of $2,250,000 in restricted marketable
securities has also been recorded as a current asset as of December 31, 1997,
as these funds have been used in 1998 to pay a portion of the principal owing
under the leases.
The principal maturities of long-term debt and minimum payments on capital
lease obligations outstanding at December 31, 1997 are as follows:
<TABLE>
<CAPTION>
Long-Term Capital
Debt Leases Total
---------- ---------- ----------
<S> <C> <C> <C>
Years ending December 31:
1998 $ 322,866 $5,305,799 $5,628,665
1999 445,411 49,149 494,560
2000 245,411 27,742 273,153
2001 245,411 1,418 246,829
2002 40,901 40,901
---------- ---------- ----------
1,300,000 5,384,109 6,684,109
Less debt discount 29,800 29,800
Less amounts representing interest 17,513 17,513
---------- ---------- ----------
$1,270,200 $5,366,596 6,636,796
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
Total interest, including amortization of financing fees, incurred in 1996
and 1997 was approximately $605,000 and $502,000, respectively. Of these
amounts, approximately $226,000
34
<PAGE>
and $474,000, respectively, were capitalized to construction-in-progress or
equipment held for sale during 1996 and 1997.
In December 1997, the Company obtained an $833,000 transaction-specific
export working capital line of credit. Borrowings under the line bear interest
at 10.5 percent per annum. No amounts were outstanding under the line at
December 31, 1997. The line expires in December 1998 if not renewed. Borrowings
under the line are secured by an interest in the Company's accounts receivable,
inventory and fixed assets.
5. INCOME TAXES
For income tax purposes, the Company has U.S. federal net operating loss
carryforwards of approximately $11,900,000 as of December 31, 1997. The
carryforwards expire in various amounts during the years 2006 through 2012.
Due to certain ownership changes, as defined in Section 382 of the Internal
Revenue Code, which occurred during the year ended December 31, 1993, the
Company's net operating loss carryforwards incurred through February 1993 of
approximately $700,000 are limited to annual utilization of approximately
$50,000 per year.
Utilization of the Company's net operating loss carryforwards was not
limited as a result of its public offering in June 1996. However, the Company's
ability to use its net operating loss carryforwards may be further limited by
subsequent issuances of common stock.
The tax benefit of 1996 and 1997 operating losses have been offset by a
valuation allowance because future realization of the net operating loss
carryforwards is uncertain.
A reconciliation of the tax benefit computed at statutory rates to the
amounts recognized in the financial statements is as follows:
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Tax benefit computed at
statutory rates $(1,686,000) $(1,863,000)
Effect of nondeductible items (44,000) 24,000
Other 2,000 (4,000)
Change in valuation allowance 1,728,000 1,843,000
----------- -----------
$ - $ -
----------- -----------
----------- -----------
</TABLE>
35
<PAGE>
Temporary differences, tax carryforwards, and valuation allowances at
December 31 consist of the following:
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Current:
Inventory valuation reserves
and other accruals $ 243,000 $ 731,000
Impairment losses not currently
deductible 776,000 565,000
Valuation allowance (1,019,000) (1,296,000)
----------- -----------
$ - $ -
----------- -----------
----------- -----------
Noncurrent:
Excess of tax over book
depreciation and amortization $ (370,000) $ (345,000)
Tax loss carryforward 2,766,000 4,307,000
Valuation allowance (2,396,000) (3,962,000)
----------- -----------
$ - $ -
----------- -----------
----------- -----------
</TABLE>
6. COMMITMENTS AND CONTINGENCIES
OPERATING LEASE COMMITMENTS - The Company is obligated under a
noncancelable operating lease for the rental of its office and manufacturing
facility through July 2001. The lease contains provisions for payment of the
facility operating expenses and real estate taxes as additional rents. During
January 1996, the Company entered into an operating lease to rent additional
manufacturing space for a term of ten years, with an option to renew the lease
for another five years at the end of the initial term. This lease contains
provisions for payment of the facility operating expenses and real estate taxes
as additional rents. Rent expense for the years ended December 31, 1996 and 1997
was approximately $150,000 and $240,000, respectively.
Minimum lease payments due under these operating leases for the next five years
are as follows:
Year ending December 31:
<TABLE>
<S> <C>
1998 $221,610
1999 221,610
2000 221,610
2001 185,672
2002 135,360
</TABLE>
36
<PAGE>
CONTINGENCIES - In connection with the coating equipment that the
Company was building for sale to the Chinese joint venture (see Note 2), the
Company entered into a contract with a third party to design and build power
supplies to be sold under the equipment contract, as well as for the
Company's own use. Due to the third party's failure to perform its
obligations, the Company rescinded the contract and demanded that the third
party refund all monies paid by the Company. The third party has asserted
that the Company is liable to it for various costs incurred in connection
with the production of the power supplies and has demanded payment of
$240,000 in addition to amounts the Company has already paid under the
contract. In June 1997, the third party formally brought an action against
the Company in Dakota County District Court. In the fourth quarter of 1997,
this third party increased its demand for damages to $1,300,000. Management,
in consultation with the Company's legal counsel, is of the opinion that the
Company has valid defenses against the claims asserted by the third party.
However, it is possible that the Company will be liable for amounts in
addition to those already paid under the contract. Such amounts could be
material but the Company is unable to estimate what amounts, if any, will
ultimately be paid.
In April 1997, the Securities and Exchange Commission (SEC) informed the
Company that it was conducting an investigation with respect to certain
financial and accounting irregularities announced by the Company in March 1997
relating to fiscal 1996. The Company has submitted documents to the SEC pursuant
to requests from the SEC as part of the investigation. In the fourth quarter of
1997, the Company was informed by the SEC that they have expanded their
investigation to include certain accounting and financial reporting
irregularities prior to 1996 which the Company announced in October 1997. The
investigation is in the preliminary stages and it is impossible to determine
what impact, if any, the investigation will have on the Company's financial
condition or results of operations.
In May of 1997 the Company was served with two separate lawsuits against
the Company, certain officers and directors of the Company, and the Company's
former president. These lawsuits were filed by certain purchasers of the
Company's common stock alleging that the Company's actions with respect to the
financial and accounting irregularities announced by the Company in March of
1997 artificially inflated its stock price between May 29, 1996 and March 24,
1997. The plaintiffs subsequently amended their complaint to make similar
allegations with
37
<PAGE>
respect to the disclosures made by the Company in October of 1997. The
plaintiffs in these actions are seeking class certification. Both suits were
filed in the United States District Court for the District of Minnesota. In July
of 1997 the court consolidated these lawsuits into a single action captioned IN
RE PHOTRAN CORPORATION SECURITIES LITIGATION. The Company has moved the Court
for an order dismissing the action; however, it is not possible at this time to
determine what impact, if any, this lawsuit will have on the Company's financial
position or results of operations.
In August 1997, the Company was served with a lawsuit by its former
president, David E. Stevenson, demanding the return of certain stock
certificates which are registered in his name which are currently in the
possession of the Company. In October 1997, the Company filed a counterclaim
alleging that Mr. Stevenson had committed fraud and had damaged the Company and
that his shares should be awarded to the Company. The Company further alleged
that Mr. Stevenson did not provide adequate consideration for such shares and,
therefore, such shares were not properly issued. This suit is in the early
stages of discovery and it is not possible to determine what impact, if any, its
outcome could have on the Company's financial condition or results of
operations.
7. SHAREHOLDERS' EQUITY
INITIAL PUBLIC OFFERING - On May 29, 1996, the Company sold 2,000,000
shares of common stock in an initial public offering. In connection with this
offering, the Company issued an overallotment option to the underwriters to
purchase up to 300,000 shares solely to cover overallotments. This option was
exercised in June 1996. Total net proceeds to the Company of the initial
offering and the overallotment option were $18,451,628 after deducting offering
costs of $2,248,372.
SUPPLEMENTARY LOSS PER SHARE - The Company utilized approximately
$7,500,000 of the net proceeds from the initial public offering to retire debt
and lines of credit outstanding. Had the Company issued a sufficient number of
shares to retire this debt, approximately 940,000 shares at a net price of $8.04
per share after deducting offering costs, as of January 1, 1996, the net loss
for the year ended December 31, 1996 would have been reduced by approximately
$125,000 in interest expense on these borrowings, and supplementary basic and
diluted loss per share for the year ended December 31, 1996 would have been
$(1.03).
AUTHORIZED SHARES - The Company's Articles of Incorporation authorize
the issuance of 24,000,000 shares of common stock, no par value, and
6,000,000 undesignated shares, no par value. The Company's Board of Directors
may designate any series and fix any relative rights and preferences of the
undesignated stock.
STOCK OPTIONS - On March 2, 1996, the Company's shareholders approved the
amendment of the Company's 1992 Stock Option Plan (the Plan) to provide for the
issuance of up to 625,000 shares of the Company's common stock under the Plan.
Under the Plan, incentive
38
<PAGE>
stock options and nonqualified stock options may be granted to key employees and
others at exercise prices not less then 85 percent of the fair market value of
the underlying common stock at the date of grant. The Board of Directors
establishes all terms and conditions of each grant. The following summarizes
stock option activity related to the Employee Stock Option Plan:
<TABLE>
<CAPTION>
Option Shares Weighted
------------------------------- Average
Outstanding Exercisable Exercise Price
----------- ----------- --------------
<S> <C> <C> <C>
Balances at December 31, 1995 76,250 39,126 $ 3.40
Granted 36,375 6.20
Canceled (9,500) 4.00
Became exercisable 14,449 3.40
--------- ---------- -----------
Balances at December 31, 1996 103,125 53,575 4.36
Granted 226,500 4.02
Canceled (49,250) (31,563) 2.60
Exercised (3,250) (2,438) 2.00
Became exercisable 16,707 4.49
--------- ---------- -----------
Balances at December 31, 1997 277,125 36,281 $ 4.13
--------- ---------- -----------
--------- ---------- -----------
The weighted average fair value of options granted during the years ended December 31, 1996
and 1997 was $4.13 and $2.96, respectively.
</TABLE>
The following table summarizes information concerning outstanding and
exercisable options under the Plan as of December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------- -------------------------
Number Weighted- Number
Outstanding Average Weighted- Exercisable Weighted-
as of Remaining Average as of Average
Range of December 31, Contractual Exercise December 31, Exercise
Exercise Prices 1997 Life in Years Price 1997 Price
------------------- ------------ ------------- --------- ------------ ---------
<S> <C> <C> <C> <C> <C>
$ 1.00 - 1.99 50,000 9.3 $ 1.88 0
2.00 - 3.99 19,750 6.3 2.50 14,750 $ 2.00
4.00 - 5.99 178,375 9.2 4.55 15,531 4.04
6.00 - 7.99 26,500 8.6 6.14 5,375 6.02
8.00 - 9.99 750 8.6 8.67 188 8.67
10.00 - 11.99 1,250 8.4 10.78 313 10.78
12.00 - 12.75 500 8.4 12.75 125 12.75
------- ------
277,125 36,281
------- ------
------- ------
</TABLE>
In addition to the options granted under the Plan, during 1994, the
Board of Directors granted an option to an unrelated party to purchase 6,875
shares of the Company's common stock at an exercise price of $4.00 per share.
39
<PAGE>
Also, during 1995, the Board of Directors granted currently exercisable
options to purchase 5,000 shares of common stock at $4.00 per share to each
outside member of the Board of Directors (for options to purchase an aggregate
of 15,000 shares of common stock). In addition, the Board of Directors
granted options to purchase 15,000 shares of common stock at $4.00 per share
to each outside member of the Board of Directors (for options to purchase an
aggregate of 45,000 shares of common stock), which vest over a three-year
period commencing March 15, 1996. In 1997, the Board of Directors granted
currently exercisable options to purchase 5,000 shares of common stock at
$1.875 per share to one outside board member. In addition, the Board of
Directors granted options to purchase 15,000 shares of common stock at $1.875
per share to each outside member of the Board of Directors (for options to
purchase an aggregate of 45,000 shares of common stock), which vest over a
three-year period commencing April 2, 1998. All options granted to members of
the Board of Directors expire ten years after the date of grant. Ten thousand
of such options which had not vested expired during March 1996 upon the
resignation of a member of the Board of Directors.
The Company has adopted the disclosure-only provisions of SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION. No compensation cost has been
recognized for the stock options granted as the exercise price at least
equalled the fair market value of the common stock at the date of grant. Had
compensation cost, consistent with the provisions of SFAS 123, for the Company's
stock option plan and options granted to the board of directors been determined
based on the fair value at the grant date, the Company's net loss and loss per
share would have been increased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Net loss - as reported $(4,816,317) $(5,323,756)
----------- -----------
----------- -----------
Net loss - pro forma $(4,848,236) $(5,458,555)
----------- -----------
----------- -----------
Basic and diluted loss per
share - as reported $ (1.15) $ (1.03)
----------- -----------
----------- -----------
Basic and diluted loss per
share - pro forma $ (1.16) $ (1.05)
----------- -----------
----------- -----------
</TABLE>
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted
average assumptions used for grants in 1995 and 1996: dividend yield of 0
percent; expected volatility of 0 percent for all grants prior to the
Company's initial public offering and 50 percent for all 1996 grants
subsequent to the Company's initial public offering; risk-free interest rate
of 5.75 percent to 6.75 percent; and expected lives of 10 years. Assumptions
used for 1997 grants were: dividend yield of 0 percent; expected volatility of
59 percent; risk-free interest rate of 5.5 percent and expected lives of
10 years.
STOCK WARRANTS - The Company has granted warrants in connection with
certain debt financing obtained during 1992, 1993, 1995, and 1997 and in
connection with common stock issued during 1993, 1994, and 1996.
40
<PAGE>
Warrants outstanding at December 31, 1996 and 1997 are as follows:
<TABLE>
<CAPTION>
NUMBER OF
SHARES EXERCISE
- -------------------- PRICE PER PERIOD
1996 1997 SHARE EXERCISABLE
- ---------- -------- -------- --------------------------------------
<S> <C> <C> <C>
49,250 10,867 $2.00 Through January 1998
129,509 127,559 2.00 Through March 1998
20,000 20,000 2.00 Through August 1998 (A)
90,000 30,000 2.00 Through September 1998
23,444 23,288 4.00 Through November 1998
43,050 43,050 4.00 Through December 1998
23,028 23,028 4.00 Through January 1999
3,250 3,250 4.00 Through February 1999
75,000 75,000 4.00 Through May 2003
400,000 400,000 6.75 Through October 2000 (B)
40,000 40,000 9.00 Through October 2000 (B)
160,000 160,000 10.80 May 1997 to 2001 (C)
15,000 2.00 March 1997 to 2002 (D)
100,000 4.00 September 1998 to 2007 (E)
10,000 4.00 February 1999 to September 2007 (E)
- ---------- ---------
1,056,531 1,081,042
- ---------- ---------
- ---------- ---------
</TABLE>
(A) During the second quarter of 1997, the board of directors approved an
extension of the expiration date of these warrants to August 1998.
Based on the market price on the date of extension, no value was
assigned to the extension.
(B) These warrants were issued in connection with the issuance of Bridge
Notes during fiscal 1995. In connection with this financing, the
Company issued warrants to the purchasers of the Bridge Notes to
purchase a total of 400,000 shares of the Company's common stock and
to the selling agent of the Bridge Note financing warrants to purchase
a total of 40,000 shares of the Company's common stock. The holders of
the warrants may convert the warrants, at any time during the exercise
period, into the number of shares of the Company's common stock
obtained by dividing the differential between the then-current market
price of the Company's common stock, as defined, and the warrant
exercise price by such current market price of the Company's common
stock. The Company has obtained a valuation of the warrants and has
determined, based on such valuation, that the value of the warrants,
if any, is not material to the financial statements.
(C) These warrants were sold to the underwriter of the Company's initial
public offering in June 1996 for a nominal price.
(D) These warrants were issued in lieu of cash to an unrelated party who
performed certain consulting services for the Company during 1997. The
warrants have been valued at $12,000, the value of the services
performed per the agreement with the third party.
41
<PAGE>
(E) These warrants were issued in connection with the shareholder loan
obtained by the Company during the third and fourth quarters of 1997.
The Company has obtained a valuation of the warrants and has
determined, based on such valuation, that the value of the warrants is
$33,800, which has been recorded as original issue discount.
8. OTHER NONRECURRING CHARGES
In the fourth quarter of 1996, the Company's joint venture partner, WABO,
notified the Company of its intention to cancel the joint venture agreement and
the related equipment purchase contract. In connection with the cancellation of
the equipment purchase contract, the Company determined that certain equipment
which was to have been sold to Fortune and was also under development for the
Company's own use was no longer economically feasible or did not fit the
Company's current manufacturing needs. This equipment has been written down to
its fair value, which in some cases was determined as its cost less a restocking
charge to the extent such equipment can be returned to the manufacturer.
Equipment which had no foreseeable future value was written off. This resulted
in a charge of approximately $1,800,000 in the fourth quarter of 1996, and an
additional charge of approximately $111,000 in the first quarter of 1997.
Also, the Company decided to discontinue its development of commercial
scale production equipment for its ZeroRay Glare and Radiation Control filters
due to technical difficulties encountered with the large scale production of the
Gelglas optical gel adhesive. Management believes that the resolution of these
technical difficulties would have required significant additional resources and
would have raised the cost of the filters to a point where the product could not
be competitive with other similar products. In connection with this decision,
management determined that, as of December 31, 1996, certain production
equipment which had been purchased to manufacture the ZeroRay product had been
impaired. This equipment was determined to have no foreseeable future value and
was written off. This resulted in a charge of approximately $378,000 in the
fourth quarter of 1996.
In addition, during the first quarter of 1997, the Company determined that as
a result of refocusing its operations, a facility it had been leasing was no
longer necessary. Leasehold improvements of $34,270 were written off in
connection with the termination of the lease agreement. Equipment, which was
determined to have no future value to the Company at March 31, 1997, was written
down to its fair value, resulting in an impairment charge of $53,652.
9. SUPPLEMENTAL CASH FLOW DISCLOSURES
Cash paid for interest was $484,160 and $279,257 for the years ended
December 31, 1996 and 1997, respectively. Property acquired by capital lease was
$40,083 for the year ended December 31, 1996. During 1997, the Company
restructured a non-cancellable operating lease, converting it to a capital lease
and obtaining equipment valued at $83,125. The remaining obligation under the
operating lease, however, was $132,711, resulting in a non-cash loss of $49,586.
42
<PAGE>
As a result of the equipment sales contracts discussed in Note 2, assets
classified as equipment held for sale to the Chinese joint venture at
December 31, 1995 are classified within property and equipment at December
31, 1996. In addition, equipment held for sale at December 31, 1996 had been
classified within property and equipment at December 31, 1995. The net effect
of the changes in classification of these two assets was a noncash transfer
from equipment held for sale to property, plant, and equipment of $3,060,314
in 1996. As a result of the cancellation of the second equipment contract
during 1997, equipment held for sale at December 31, 1996 has been classified
as property and equipment at December 31, 1997. The effect of this change was
a noncash transfer from equipment held for sale to property and equipment of
$907,812 during 1997.
The Company is refunding the down payment obtained (plus accrued interest)
on the cancelled equipment contract discussed above via credits against glass
purchases by the customer. During 1997, a total of $239,967 in credits have been
applied to accounts receivable from this customer. Customer advances and accrued
interest payable have been reduced by the same amount.
During 1996, the Company received equipment with an estimated fair value of
$25,000 from a customer in lieu of payment on accounts receivable.
10. SUBSEQUENT EVENTS
In February 1998, the Company issued a $3,500,000 convertible note in a
private financing transaction. The proceeds of the financing will be used
primarily to fund the $1,500,000 settlement with WABO (see Note 2) and complete
the construction and installation of the Company's P-2 and P-3 lines. The note
bears interest at 10 percent per annum and matures in August 1999. All principal
and accrued interest are payable at maturity, but may be prepaid at any time
without penalty. The note and all accrued interest are convertible into
shares of common stock of the Company at the option of the lender at any time
up to 30 days following maturity, at a rate of $4.00 per share. The note is
secured by an interest in substantially all of the fixed assets of the
Company, except the P-3 production line which is the subject of a
sale-leaseback transaction. In connection with this transaction, the Company
issued to the lender a five-year warrant to purchase 1,225,000 shares of
common stock of the Company at $4.00 per share.
In February 1998, as consideration for extension of the $1,100,000 loan
and modification of the security interest collateralizing the loan, the
Company issued a warrant to a shareholder who is also a director to purchase
100,000 shares of common stock of the Company at $4.25 per share. The warrant
is exercisable from February 1999 to September 2007.
43
<PAGE>
ITEM 8 - CHANGES IN AND DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
There have been no changes in or disagreements with the Company's independent
auditors during the two most recent fiscal years.
PART III
ITEM 9 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
MANAGEMENT
The following table sets forth certain information concerning each of the
Company's directors and executive officers as of December 31, 1997:
NAME AGE POSITION
Paul T. Fink (1)(2) 42 President, Chief Executive Officer, and Director
Judith E. Tucker 35 Chief Financial Officer, Secretary, Treasurer
Robert S. Clarke (3) 54 Director
Steven King (1)(2) 52 Chairman of the Board, Director
Frank Brantman (3) 53 Director
(1) Member of Compensation Committee.
(2) Member of Governance Committee.
(3) Member of Audit Committee.
The Board of Directors is divided into three classes, and directors serve
for staggered three-year terms. Robert S. Clarke and Steven King serve in a
class with a term expiring in 1998; Paul T. Fink serves in a class with a term
expiring in 1999. Frank Brantman serves in a class with a term expiring in 2000.
Officers serve at the discretion of the Board of Directors.
PAUL T. FINK has been employed by the Company since January 1995. Mr. Fink
joined the Company as Controller, was named Chief Financial Officer in February
1996 and was elected as a Director in March 1996. Mr. Fink was named President
and Chief Executive Officer in August 1997. Prior to joining the Company, Mr.
Fink was employed as the Chief Financial Officer of Vomela Specialty Company,
St. Paul, Minnesota, from 1989 to 1994 and Com-Tal Machine and Engineering,
Vadnais Heights, Minnesota, from 1984 to 1989. Mr. Fink was employed by
McGladrey & Pullen, Certified Public Accountants, as an auditor from 1980 to
1984. Mr. Fink holds a Bachelor of Science degree in Accounting from the
University of Minnesota, a Masters of Business Administration degree in
Financial Management from the University of St. Thomas, and is also a Certified
Public Accountant.
JUDITH E. TUCKER joined the Company in July of 1997 in the position of
controller. Ms. Tucker was named Vice President for Finance and Administration
and Chief Financial Officer in
44
<PAGE>
August 1997. Prior to joining the Company, Ms. Tucker was employed by Deloitte
and Touche LLP, as an auditor from 1990 to 1997. Ms. Tucker holds a Bachelor of
Science in Business (Accounting) from the University of Minnesota and is also a
Certified Public Accountant.
ROBERT S. CLARKE has been a director of the Company since March 1993. Since
1981 Mr. Clarke has been the President of Alpen, Inc., Boulder, Colorado, a
leading manufacturer of architectural insulating glass. Since 1991 Mr. Clarke
has also been President, Chairman and a director of Vac-Tec Systems, Inc., a
public company involved in the manufacture of high performance windows utilizing
suspended vacuum-coated films.
STEVEN KING has been a director of the Company since May 1993 and was
elected Chairman of the Board in March 1997. Since 1986 Mr. King has been
Chairman and CEO of Landscape Structures, Inc., of Delano, Minnesota, a company
that creates and manufactures innovative play structures promoting early
childhood development. Mr. King is also a registered architect.
FRANK BRANTMAN has been a director of the Company since October of 1996.
Since 1988 he has been president of Leaf Industries, Inc., Minneapolis,
Minnesota, a contract manufacturer. Mr. Brantman is also executive vice
president and director of BMB, Inc., a Lake Forest, Illinois, medical products
company. Mr. Brantman has significant private and public board experience.
SECTION 16 (a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16 (a) of the Securities Exchange Act of 1934 requires the
Company's executive officers and directors to file initial reports of ownership
and reports of changes in ownership of common stock of the Company with the
Securities and Exchange Commission (SEC). Executive officers, directors and
persons who beneficially own more than ten percent of the common stock of the
Company are required by SEC regulations to furnish the Company with copies of
all Section 16 (a) forms they file. Based solely on a review of the copies of
such forms furnished to the Company and written representations from the
Company's officers and directors, all Section 16 (a) filing requirements
applicable to the Company's executive officers and directors have been
satisfied.
ITEM 10 - EXECUTIVE COMPENSATION
The following table sets forth certain information regarding compensation
paid during each of the Company's last three fiscal years to the Company's Chief
Executive Officer. No other employee of the Company received salary and bonus in
excess of $100,000 for the covered periods:
45
<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long-Term
Compensation
Awards
--------------
Annual Compensation Securities
----------------------------- Underlying
Name And Principal Position Fiscal Year Salary Options (1)
--------------------------- ----------- ------ --------------
<S> <C> <C> <C>
Paul T. Fink . . . . . . . . . . . 1997 $ 112,215 125,000 (3)
Chief Executive Officer
and Director (2)
David E. Stevenson . . . . . . . . 1996 86,719 --
Former Chief Executive
Officer and Chairman (4) 1995 81,560 25,000 (5)
</TABLE>
(1) Number of shares of Common Stock subject to options granted during the year
indicated.
(2) Named Chief Executive Officer in August 1997.
(3) Options to purchase 125,000 shares were granted to Mr. Fink as part of his
1997 compensation as an officer and employee of the Company.
(4) Resigned in March 1997.
(5) Options to purchase 25,000 shares were granted to Mr. Stevenson as part of
his 1995 compensation as an officer and employee of the Company. These
options expired unexercised in 1997.
EMPLOYMENT AGREEMENT
The Company has executed an employment agreement with Paul T. Fink, its
president. The agreement has an initial term through December 31, 1999, and
automatically renews for successive one-year terms unless either party gives 60
days written notice of non-renewal. The agreement also provided for the issuance
of options for the purchase of 100,000 shares of the Company's common stock to
Mr. Fink upon execution of the agreement.
STOCK OPTIONS
On December 15, 1992, the Board of Directors and shareholders of the
Company adopted the 1992 Stock Option Plan (the "Plan") in order to provide for
the granting of stock purchase options to employees and officers of the Company.
The Plan permits the granting of incentive stock options meeting the
requirements of Section 422A of the Internal Revenue Code of 1986, as amended,
and also nonqualified stock options which do not meet the requirements of such
section. As amended by the Board of Directors and approved by the shareholders
in February of 1996, the Company has reserved 625,000 shares of its common stock
for issuance upon the exercise of options granted under the Plan. As of the date
of this report, the Company has outstanding options to purchase an aggregate of
277,125 shares under the Plan.
46
<PAGE>
OPTIONS GRANTED FOR THE YEAR ENDED DECEMBER 31, 1997
The following table summarizes the options granted to named executive
officers during the latest fiscal year:
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
Number of % of Total
Securities Options
Underlying Granted to
Options Employees in Exercise Expiration
Name Granted Fiscal Year Price Date
--------------- ---------- ------------ -------- --------------
<S> <C> <C> <C> <C>
Paul T. Fink 25,000 12% $ 1.88 April 2007
100,000 48% 4.50 August 2007
</TABLE>
AGGREGATE OPTION VALUES AT DECEMBER 31, 1997
The following table sets forth certain information at December 31, 1997, as
to options held by the Company's Chief Executive Officer:
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
Number Of Unexercised Value Of Unexercised in the
Options At 12/31/97 Money Options at 12/31/97 (1)
Name Unexercisable Exercisable Unexercisable Exercisable
-------------- ------------- ----------- ------------- -----------
<S> <C> <C> <C> <C>
Paul T. Fink 130,000 5,000 $ 64,375 $ 1,875
</TABLE>
(1) The value of exercisable options is equal to the difference between the
December 31, 1997 market price per share and the option exercise price per share
multiplied by the number of shares subject to options.
COMPENSATION OF DIRECTORS
Directors were paid $500 per meeting for attending meetings in 1997. All
directors are reimbursed for their travel expenses incurred in attending Board
meetings.
During 1995, the Board of Directors granted currently exercisable options
to purchase 5,000 shares of common stock at $4.00 per share to each outside
member of the Board of Directors (for options to purchase an aggregate of 15,000
shares of common stock). In addition, the Board of Directors granted options to
purchase 15,000 shares of common stock at $4.00 per share to each outside member
of the Board of Directors (for options to purchase an aggregate of 45,000 shares
of common stock), which vest over a three-year period commencing March 15, 1996.
In 1997, the Board of Directors granted currently exercisable options to
purchase 5,000 shares of common stock at $1.875 per share to one outside board
member. In addition, the Board of Directors granted options to purchase 15,000
shares of common stock at $1.875 per share to each outside
47
<PAGE>
member of the Board of Directors (for options to purchase an aggregate of 45,000
shares of common stock), which vest over a three-year period commencing April 2,
1998. All options granted to members of the Board of Directors expire ten years
after the date of grant. Ten thousand of such options which had not vested
expired during March 1996 upon the resignation of a member of the Board of
Directors. This director, who is a sitting judge, resigned prior to the
Company's initial public offering due to an ethical conflict of interest
relating to a judge serving on the board of a public company.
ITEM 11 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of March 15, 1998 certain information
regarding beneficial ownership of the Company's Common Stock by (i) each person
known by the Company to be the beneficial owner of more than 5 percent of the
outstanding Common Stock, (ii) each director of the Company, (iii) each Named
Executive Officer, and (iv) all executive officers and directors of the Company
as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY PERCENT
NAME AND ADDRESS OWNED (1) OWNERSHIP
<S> <C> <C>
DIRECTORS AND OFFICERS (2):
Paul T. Fink (3) 13,750 *
Judith E. Tucker -- --
Robert S. Clarke (4) 25,000 *
Steven King (5) 346,319 6.62%
Frank Brantman (6) 10,000 *
All executive officers and
directors as a group (5 persons) (7) 395,069 7.55%
</TABLE>
* Less than 1%.
(1) Shares not outstanding but deemed beneficially owned by virtue of the
individual's right to acquire them as of the effective date of this filing,
or within 60 days of such date, are treated as outstanding when determining
the percent of the class owned by such individual and when determining the
percent owned by the group. Unless otherwise indicated, each person named
or included in the group has sole voting and investment power with respect
to the shares of common stock set forth opposite the shareholder's name.
(2) The address of each director and officer of the Company is 21875 Grenada
Avenue, Lakeville, MN 55044.
(3) Represents 13,750 shares of common stock issuable pursuant to currently
exercisable options.
(4) Represents 25,000 shares of common stock issuable pursuant to currently
exercisable options.
(5) Includes (i) 25,000 shares of common stock issuable pursuant to currently
exercisable options, (ii) 95,000 shares of common stock issuable pursuant
to currently exercisable warrants, and (iii) 100,000 shares issuable upon
conversion of outstanding promissory notes.
48
<PAGE>
(6) Represents 10,000 shares of common stock issuable pursuant to currently
exercisable options.
(7) Includes 268,750 shares issuable pursuant to currently exercisable options
and warrants, and upon conversion of outstanding promissory notes.
ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Steven King, a director of the Company, made a loan to the Company in the
original principal amount of $1,500,000 on May 1, 1995 for working capital and
general corporate purposes. The note issued in connection with the loan bore
interest from the date of issue at an annual rate of 3.75 percent in excess of
the "Reference Rate" announced from time to time by First Bank National
Association, and was secured by substantially all equipment and intellectual
property of the Company. The note was subject to periodic payments of principal
and accrued interest. The note was repaid without penalty in June 1996. In
connection with this loan, warrants to purchase up to 75,000 shares of common
stock were issued to Mr. King. The warrants are exercisable at any time after
April 30, 1996, and expire on May 1, 2003. The exercise price of these warrants
is $4.00 per share.
In September 1997, Steven King made a loan to the Company in the amount of
$1,000,000. The loan bears interest at 3.5 percent over the reference rate, as
defined, and is payable in monthly installments through February 2002. In
connection with the loan, the Company issued to Mr. King warrants for the
purchase of 100,000 shares of the Company's common stock at a price of $5.00 per
share. The warrants are exercisable between September 1998 and September 2007.
In November 1997, Mr. King increased the loan by $100,000, and warrants to
purchase an additional 10,000 shares of common stock at $4.00 per share were
issued to him by the Company.
In February 1998, as consideration for extension of the loan and
modification of the security agreement collateralizing the loan, the Company
issued warrants to purchase an additional 100,000 shares of common stock to
Mr. King. These warrants are exercisable between February 1999 and September
2007 at a price of $4.25 per share.
All of the above warrants provide for the automatic adjustment of the
number of shares issuable upon exercise of the warrants, and of the exercise
price, in certain events, including stock dividends, stock splits,
reorganizations, reclassifications and the merger, consolidation or sale of all
or substantially all of the assets of the Company. The warrants grant certain
registration rights with respect to the stock issuable upon exercise of the
warrants in the event the Company proposes to register any shares of its common
stock under the Securities Act of 1933. These registration rights are not
applicable under certain circumstances.
49
<PAGE>
ITEM 13. EXHIBITS
(a) Exhibits.
The following exhibits are included with this Annual Report on Form 10-KSB
(or incorporated by reference) as required by Item 601 of Regulation S-B.
EXHIBIT
NO. DESCRIPTION
- ------- -----------
1.1 Representative's Warrant to purchase 160,000 shares of Common Stock,
dated June 3, 1996, granted to John G. Kinnard and Company,
Incorporated. *
3.1 Second Amended and Restated Articles of Incorporation of Photran
Corporation, effective March 2, 1996*
3.2 Amended and Restated By-Laws of Photran Corporation, effective
December 23, 1992 as amended through February 3, 1996. *
4.1 Second Amended and Restated Articles of Incorporation and Amended and
Restated By-Laws of Photran Corporation as amended. (See Exhibits 3.1
and 3.2 above.) *
4.2 Specimen of Common Stock Certificate. *
4.4 Form of Common Stock Purchase Warrant. Identical Common Stock Purchase
Warrants in the amounts of 20,000 shares, 14,500 shares, 14,750 shares,
92,482 shares, and 52,627 shares were granted to R.J. Steichen &
Company on November 1, 1992, December 1, 1992, January 5, 1993,
February 19, 1993 and March 17, 1993, respectively. *
4.5 Form of Warrant for Purchase of Shares of Common Stock. Identical
Warrants for Purchase of Shares of Common Stock in the amounts of
20,000 shares and 60,000 shares were granted to a total of eleven
individuals on August 8, 1993 and September 23, 1993, respectively. *
4.6 Form of Agent's Common Stock Purchase Warrant. Identical Agent's Common
Stock Purchase Warrants in the amounts of 5,750 shares and 24,250
shares were granted to R.J. Steichen & Company on September 23, 1993
and September 24, 1993, respectively. *
4.7 Form of Stock Purchase Warrant. Identical Stock Purchase Warrants in
the amounts of 23,444 shares, 44,519 shares, and 23,028 shares were
granted to R.J. Steichen & Company on November 17, 1993, December 14,
1993, and January 31, 1994, respectively. *
4.8 Form of Stock Purchase Warrant for 75,000 shares of Common Stock, dated
May 1, 1995, granted to Steven King. *
4.9 Form of Warrant for Purchase of Shares of Common Stock. Identical
Warrants for Purchase of Shares of Common Stock were granted to a total
of 28 individuals on October 15, 1995 to purchase a total of 400,000
shares. *
4.10 Agent's Warrant to Purchase 40,000 shares of Common Stock, dated
October 31, 1995, granted to John G. Kinnard and Company,
Incorporated. *
50
<PAGE>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
4.12 Loan Agreement dated September 10, 1997 between Photran Corporation and
Steven King. (incorporated by reference to the Registrant's Quarterly
Report on Form 10-QSB for the quarter ended September 30, 1997)
4.13 Loan Agreement dated December 31, 1997 between Photran Corporation and
Community National Bank **
10.1 Contract Agreement for the Joint Venture of Shenzhen Fortune Conductive
Glass Company, Ltd., between Photran Corporation and Shenzhen Wabo
(Group) Company, Limited. *
10.3 Office Warehouse Lease between Owobopte Rehabilitation Industries, Inc.
and Photran Corporation dated July 1991. *
10.4 Photran Corporation 1992 Stock Option Plan. *
10.5 Form of Incentive Option Agreement. Identical Incentive Option
Agreements were entered into with 66 employees for purchase of a total
of 76,250 shares.*
10.7 Office Warehouse Lease between Sparta Foods, Inc. and Photran
Corporation dated December 21, 1995. *
10.8 Equipment Lease between Textron and Photran Corporation dated June 21,
1995.*
10.10 Equipment Lease Agreement between Photran Corporation and NBD Equipment
Finance, Inc. dated February 13, 1997. (incorporated by reference to
the Registrant's Annual Report on Form 10-KSB for the year ended
December 31, 1996.)
10.11 Employment contract between Paul T. Fink and Photran Corporation dated
August 1, 1997 (incorporated by reference to the Registrant's Quarterly
Report on Form 10-QSB for the quarter ended September 30, 1997)
10.12 Settlement Agreement between Shenzhen WABO Group Co., Ltd. and Photran
Corporation dated January 17, 1998. (incorporated by reference to the
Registrant's Quarterly Report on Form 10-QSB for the quarter ended
September 30, 1997)
23.1 Consent of Deloitte & Touche LLP. **
27.1 Financial Data Schedule - 1997. **
27.2 Financial Data Schedule - 1996. **
- ---------------------------------
* Incorporated by reference to the Registrant's Registration Statement on Form
SB-2, declared effective May 29, 1996.
** Denotes document filed herewith.
51
<PAGE>
(b) Reports on Form 8-K.
The Company filed a Form 8-K on November 5, 1997 concerning its lawsuit
against its former president and founder, David E. Stevenson, alleging
fraud, and announcing the possibility of further historical financial
statement restatements.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PHOTRAN CORPORATION
Date: March 31, 1998
By: /s/ Paul T. Fink
-------------------------
Paul T. Fink
Chief Executive Officer
By: /s/ Judith E. Tucker
-------------------------
Judith E. Tucker
Chief Financial Officer
By: /s/ Steven King
-------------------------
Steven King
Chairman of the Board
By: /s/ Robert S. Clarke
-------------------------
Robert S. Clarke
Director
By: /s/ Frank L. Brantman
-------------------------
Frank L. Brantman
Director
52
<PAGE>
INDEX TO EXHIBITS
EXHIBIT
NO. DESCRIPTION
- ------- -----------
1.1 Representative's Warrant to purchase 160,000 shares of Common Stock,
dated June 3, 1996, granted to John G. Kinnard and Company,
Incorporated. *
3.1 Second Amended and Restated Articles of Incorporation of Photran
Corporation, effective March 2, 1996*
3.2 Amended and Restated By-Laws of Photran Corporation, effective December
23, 1992 as amended through February 3, 1996. *
4.1 Second Amended and Restated Articles of Incorporation and Amended and
Restated By-Laws of Photran Corporation as amended. (See Exhibits 3.1
and 3.2 above.) *
4.2 Specimen of Common Stock Certificate. *
4.4 Form of Common Stock Purchase Warrant. Identical Common Stock Purchase
Warrants in the amounts of 20,000 shares, 14,500 shares, 14,750 shares,
92,482 shares, and 52,627 shares were granted to R.J. Steichen & Company
on November 1, 1992, December 1, 1992, January 5, 1993, February 19,
1993 and March 17, 1993, respectively. *
4.5 Form of Warrant for Purchase of Shares of Common Stock. Identical
Warrants for Purchase of Shares of Common Stock in the amounts of 20,000
shares and 60,000 shares were granted to a total of eleven individuals
on August 8, 1993 and September 23, 1993, respectively. *
4.6 Form of Agent's Common Stock Purchase Warrant. Identical Agent's Common
Stock Purchase Warrants in the amounts of 5,750 shares and 24,250 shares
were granted to R.J. Steichen & Company on September 23, 1993 and
September 24, 1993, respectively. *
4.7 Form of Stock Purchase Warrant. Identical Stock Purchase Warrants in the
amounts of 23,444 shares, 44,519 shares, and 23,028 shares were granted
to R.J. Steichen & Company on November 17, 1993, December 14, 1993, and
January 31, 1994, respectively. *
4.8 Form of Stock Purchase Warrant for 75,000 shares of Common Stock, dated
May 1, 1995, granted to Steven King. *
4.9 Form of Warrant for Purchase of Shares of Common Stock. Identical
Warrants for Purchase of Shares of Common Stock were granted to a total
of 28 individuals on October 15, 1995 to purchase a total of 400,000
shares. *
4.11 Agent's Warrant to Purchase 40,000 shares of Common Stock, dated October
31, 1995, granted to John G. Kinnard and Company, Incorporated. *
53
<PAGE>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
4.12 Loan Agreement dated September 10, 1997 between Photran Corporation and
Steven King. (incorporated by reference to the Registrant's Quarterly
Report on Form 10-QSB for the quarter ended September 30, 1997)
4.13 Loan Agreement dated December 31, 1997 between Photran Corporation and
Community National Bank **
10.1 Contract Agreement for the Joint Venture of Shenzhen Fortune Conductive
Glass Company, Ltd., between Photran Corporation and Shenzhen Wabo
(Group) Company, Limited. *
10.2 License Agreement between Photran Corporation and Applied Elastromerics
dated May 30, 1991, as amended. *
10.3 Office Warehouse Lease between Owobopte Rehabilitation Industries, Inc.
and Photran Corporation dated July 1991. *
10.4 Photran Corporation 1992 Stock Option Plan. *
10.5 Form of Incentive Option Agreement. Identical Incentive Option
Agreements were entered into with 66 employees for purchase of a total
of 76,250 shares.*
10.7 Office Warehouse Lease between Sparta Foods, Inc. and Photran
Corporation dated December 21, 1995. *
10.8 Equipment Lease between Textron and Photran Corporation dated June 21,
1995.*
10.10 Equipment Lease Agreement between Photran Corporation and NBD Equipment
Finance, Inc. dated February 13, 1997. (incorporated by reference to the
Registrant's Annual Report on Form 10-KSB for the year ended December
31, 1996.)
10.11 Employment contract between Paul T. Fink and Photran Corporation dated
August 1, 1997 (incorporated by reference to the Registrant's Quarterly
Report on Form 10-QSB for the quarter ended September 30, 1997)
10.12 Settlement Agreement between Shenzhen WABO Group Co., Ltd. and Photran
Corporation dated January 17, 1998. (incorporated by reference to the
Registrant's Quarterly Report on Form 10-QSB for the quarter ended
September 30, 1997)
23.1 Consent of Deloitte & Touche LLP. **
27.1 Financial Data Schedule - 1997. **
27.2 Financial Data Schedule - 1996. **
- ---------------------------------
* Incorporated by reference to the Registrant's Registration Statement on Form
SB-2, declared effective May 29, 1996.
** Denotes document filed herewith.
54
<PAGE>
LOAN AGREEMENT
THIS LOAN AGREEMENT ("Agreement") is entered into as of the 31st day of
December, 1997, by and between Photran Corporation, a Minnesota corporation,
whose address is 21875 Grenada Avenue, Lakeville, Minnesota 55044 (hereinafter
referred to as the "Borrower") and Community National Bank, a national banking
corporation, whose address is 25 Bridge Square, Northfield, Minnesota 55057
(hereinafter referred to as the "Lender").
The Borrower has requested the Lender to make a loan (hereinafter referred
to as the "Loan") to the Borrower for business purposes, and the Lender is
willing to make such a Loan subject to the terms and conditions of this
Agreement.
NOTE AND INTEREST RATE
The note shall be for a maximum principal amount of Eight Hundred Thirty
Three Thousand Dollars ($833,000.00) ("Note"). The Note shall bear multiple
advance and open end features. In no event shall an advance be made under the
Note at a later date than November 27, 1998.
Interest shall accrue on the Note at the rate of ten and one-half percent
(10.50%) per annum. The interest rate shall be fixed for the term of the Note
and shall be calculated on a 360 day year basis.
CONDITIONS OF LENDING
The Borrower shall continue to comply with all agreements and conditions
contained in this Agreement, the Loan Documents and any other document executed
in connection with the Loan.
The obligation of the Lender to make the Loan to the Borrower is subject to
the condition that the Lender shall have received on or before the date of such
Loan, each of the following documents or instruments, in a form and in substance
satisfactory to the Lender and to the Lender's counsel:
a. The Note, described above, executed by the Borrower;
b. Security Agreement, executed by the Borrower;
c. UCC-1 Financing Statement, executed by the Borrower;
d. Security Interest Clarification Letter, executed by Textron Financial
Corporation;
e. Security Interest Subordination Agreement, executed by Henson & Efron,
P.A.;
f. Lockbox Agreement, executed by the Borrower;
<PAGE>
g. The U.S. Small Business Administration Authorization and Loan
Agreement, executed by Borrower (collectively the "Loan Documents");
and
h. Security interest estoppel letter from Steven King.
The initial advance and any future advances on the Loan shall be permitted,
upon Lender approval and provided that no default exists under and Borrower is
in full compliance with this Agreement and the Loan Documents, subject to the
following terms and conditions:
a. Requested advance is less than seventy-five percent (75%) of export
purchase order which is supported by either an irrevocable letter of
credit assigned to Lender or export credit insurance; and
b. Requested advance does not exceed aggregate limit of Eight Hundred
Thirty-Three Thousand Dollars ($833,000.00); and
c. Sufficient collateral exists, subject to the borrowing base
certificate which is attached as Exhibit "A" ("Borrowing Base"), so
that the collateral balance exceeds the outstanding loan balance plus
the requested advance.
ISSUANCE OF LETTERS OF CREDIT
Subject to the Borrowing Base and so long as in doing so Borrower's
indebtedness to Lender under the Note together with all Letters of Credit issued
on Borrower's behalf do not exceed $833,000.00, Borrower may request and Lender
shall issue letters of credit on Borrower's behalf. As a further condition
precedent, Borrower shall execute individual applications for each requested
Letter of Credit.
FINANCIAL STATEMENTS AND BORROWER WARRANTIES
The Lender has relied upon financial statements prepared by and on behalf
of the Borrower in extending this Loan. Borrower warrants that the financial
statements and supporting schedules are true and correct to the best of their
knowledge and fairly represents their financial condition today.
Notwithstanding the foregoing, Lender acknowledges that it has been advised by
Borrower that Borrower's financial statements may contain certain misstatements
about the financial condition and results of operations of the Borrower. Lender
acknowledges that it has been provided with proposed changes to the financial
statements which statements are being reviewed by Borrower's auditors. To the
best of Borrower's knowledge, the financial statements, once revised as proposed
by Borrower, will in all material respects fairly present the financial
condition and the results of operations of the Borrower for the periods
described therein.
The Borrower warrants that they own the collateral and that it is free and
clear of all liens and encumbrances except as disclosed to the Lender. Except
for loan agreements by and between Steven King, NBD Equipment Finance, Inc. and
Borrower, the Borrower warrants that they are not in default on other loans or
loan agreements with third parties and that all federal, state and local tax
returns have been filed and all taxes paid, as required. The Borrower agrees to
execute all other
<PAGE>
supporting loan documents which may from time to time be required to perfect or
maintain the Lender's rights to repayment and to the collateral pledged to
secure the Loan. Whenever Borrower obtains an advance supported by an
irrevocable letter of credit, such advance shall constitute Borrower's absolute
assignment to Lender of the subject irrevocable letter of credit. Borrower
agrees that until all indebtedness has been paid to the Lender, they shall:
a. Comply with the terms and conditions of this Agreement and all Loan
Documents which specifically include but are not limited to the
Authorization and Loan Agreement by and between Lender, Photran
Corporation and the U.S. Small Business Administration dated December
18, 1997;
b. Allow the Lender to inspect the collateral and Borrower's books and
records periodically as requested;
c. Maintain the primary payroll account for Borrower with the Lender; and
d. Maintain an operating account for Borrower with the Lender.
EVENTS OF DEFAULT
Borrower understands that the Lender may declare the entire debt due and
payable should the Borrower:
a. Fail to pay principal, interest and other charges when due under the
Note;
b. Materially breach any agreement contained in this Agreement or any
Loan Document;
c. An event of default is declared and remaining continuing under any
other financing arrangement Borrower has with a third party which is
secured in any way by any assets of Borrower, and such third party has
exercised or notified Lender of its intent to exercise any of its
remedies against Borrower by reason of such event of default;
d. Represent to Lender information that is materially false; or
e. File a petition in Bankruptcy or take other steps evidencing
insolvency (whether in the equity sense or the bankruptcy sense).
Where applicable, Borrower has an affirmative duty to notify Lender the same day
Borrower has actual knowledge of a default as described above.
REMEDIES AND WAIVER
All of the Lender's rights hereunder are cumulative and shall be in
addition to all rights granted to the Lender by law, and nothing herein shall be
deemed to be a limitation upon any of the Lender's rights granted by law or in
any Loan Document. Failure of the Lender to exercise any right
<PAGE>
or power under this Agreement or any Loan Document shall not constitute a waiver
of the Lender's rights to declare the debt immediately due and payable or to
institute or pursue collection thereof. Nothing in this Agreement shall be
deemed a waiver or prohibition of Lender's right of a banker's lien, offset or
counterclaim, which right the Borrower hereby grants Lender.
ATTORNEYS' FEES
The Borrower promises to pay all costs of collection, including but not
limited to, reasonable attorney's fees paid or incurred by the Lender on account
of the enforcement or interpretation of Lender's rights under this Agreement or
any Loan Document whether or not suit is filed with respect thereto and whether
or not such cost or expense is paid or incurred or to be paid or incurred prior
to or after the entry of judgment or for the pursuance of, or defense of, any
appellate procedure.
CONSISTENCY
In the event that any of the terms and provisions of this Agreement are
inconsistent with any of the terms and provisions as contained in any of the
Loan Documents, Lender may enforce such terms and provisions which it, in its
sole discretion, deems to best protect its interests, and, the Borrower waives
any objections thereto despite the existence of any such inconsistency.
ACCEPTANCE
The Borrower's signature below indicates their approval of all of the terms
in this Agreement. This Agreement shall become a contract between the Lender
and Borrower, with the Loan Documents being incorporated by reference and
becoming a part of the contract.
PHOTRAN CORPORATION
(a Minnesota corporation)
By: /s/ Judy Tucker
-----------------------------------
Judy Tucker
Its Chief Financial Officer
COMMUNITY NATIONAL BANK
(a national banking corporation)
By: /s/ Kevin T. Kelly
-----------------------------------
Kevin T. Kelly
Its Commercial Loan Officer
<PAGE>
EXHIBIT "A"
BORROWING BASE CERTIFICATE
FOR: Photran Corporation
21875 Grenada Avenue
Lakeville, MN 55044
TO: Community National Bank
25 Bridge Square, P. O. Box 280
Northfield, MN 55057
Pursuant to a Loan Agreement between Community National Bank and the undersigned
dated December 31, 1997, the undersigned certifies that as of ________________,
it has export purchase orders to be used for draws which are supported by the
following accounts receivable and inventory and that all of said accounts
receivable and export purchase orders are 100% covered by irrevocable letters of
credit and/or credit insurance and that any draw request is in compliance with
the Loan Agreement.
1. Accounts receivable supported with an irrevocable letter
of credit assigned to Bank or export credit insurance less
than 75 days past due
-----------
2. Less: Discount of 25% of accounts receivable (25% X #1) ( )
-----------
3. Total available accounts receivable (#1 - #2)
-----------
4. Inventory
-----------
5. Less: Discount of 50% of inventory (50% X #4) ( )
-----------
6. Total available inventory (#4 - #5)
-----------
7. Total available borrowing base (#3 + #6)
-----------
8. Less: Loan balance ( )
-----------
9 Subtotal available borrowing base (#7 - #8)
-----------
10. Less: Outstanding letters of credit ( )
-----------
11. Available credit (#9 - #10)
-----------
The loan balance does not exceed total available borrowing base and any
requested draws do not exceed the available credit. The undersigned is not in
default under this borrowing base or any other covenants of the Loan Agreement.
PHOTRAN CORPORATION
(a Minnesota corporation )
By:
----------------------------------------
Judy Tucker
Its Chief Financial Officer
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
333-07741 of Photran Corporation on Form S-8 of our report dated March 25,
1998 (which report includes an explanatory paragraph concerning the Company's
ability to continue as a going concern), appearing in this Annual Report on
Form 10-KSB of Photran Corporation for the year ended December 31, 1997.
DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
March 25, 1998
60
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 46,107
<SECURITIES> 2,250,000
<RECEIVABLES> 733,222
<ALLOWANCES> (11,109)
<INVENTORY> 387,000
<CURRENT-ASSETS> 3,443,034
<PP&E> 20,659,493
<DEPRECIATION> (2,124,345)
<TOTAL-ASSETS> 21,978,183
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